Financing for Sustainable Development Report 2020

CMY CY MY CM K Y M C

19-0108420-02510 Cover_Final-2b-11x17-2020.pdf 13/31/201:29PM

2020 Report Development Sustainable for Financing Financing forSustainableDevelopmentReport2020 Inter-agency Task Force onFinancingforDevelopment Domestic PublicDomestic Domestic PublicDomestic Resources Resources etSystemic Debt etSsei Technology Systemic Debt Private Business Private Business and Finance and Finance Issues Issues Development Development and Capacity and Capacity Cooperation Cooperation Technology MORE READ Tr Tr ade ade Report of the Inter-agency Task Force on Financing for Development

FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT 2020

United Nations New York, 2020 This report is a joint product of the members of the Inter-agency Task Force on Financing for Development. The Financing for Sustainable Development Offi ce of the United Nations Department of Economic and Social Aff airs serves as the coordinator and substantive editor of the Financing for Sustainable Development report. The online annex of the Task Force (http://developmentfi nance.un.org) comprehensively monitors progress in implementation of the Financ- ing for Development outcomes, including the Addis Ababa Action Agenda and relevant means of implementation targets of the Sustainable Development Goals. It provides the complete evidence base for the Task Force’s annual report on progress in the seven action areas of the Addis Agenda (chapters III.A–III.G). The report is by necessity more concise and selective and should thus be read in conjunction with the online annex. Inquiries about the Task Force or its report and online annex can be sent to: Financing for Sustainable Development Offi ce Department of Economic and Social Aff airs 2 United Nations Plaza (DC2- 2170) New York, N.Y. 10017 United States of America +1-212-963-4598 developmentfi [email protected] http://developmentfi nance.un.org

The production of this report and the online annex of the Inter-agency Task Force are generously supported by the Federal Ministry for Economic Cooperation and Development of Germany.

How to cite this report: United Nations, Inter-agency Task Force on Financing for Development, Financing for Sustainable Development Report 2020. (New York: United Nations, 2020), available from: https://developmentfi nance.un.org/fsdr2020.

This report is being issued as the impacts of the COVID-19 pandemic grow deeper and more devastating. Already we see the rising risk of a global recession, and disproportionate suff ering by the most vulnerable members of the human family. We must act quickly and decisively to protect people and strengthen societies in the face of this shock, which comes on top of a global climate emergency, soaring inequality and growing discontent with the economic and social order in general. Beyond the necessary and immediate interventions in the realm of global public health, the 2030 Agenda for Sustainable Development remains humankind’s best blueprint for fi nding solutions to our biggest challenges. Mobilizing fi nancing is critical to supporting emerging economies and developing countries. This United Nations report points the way. The immediate focus must be on reversing the trajectory of the COVID-19 pandemic, and responding to the unfolding economic crisis. Public health spending must increase, and rapid income support needs to be provided to those who lose jobs and business. This is particularly important for the poorest without health care and those with precarious employment. Concessional lending programmes for small and mid-sized enterprises, as well as waivers on loan repayments, will also be necessary. Rapid response measures should be coordinated at the global level to ensure maximum impact and to signal shared resolve to maintain economic and fi nancial stability, promote trade and stimulate growth. While the pandemic continues to evolve, the future landscape will be uncertain, especially for those countries less able to cope. This report identifi es four key areas of long-term action to promote stability and well-being: First, reversing the backsliding we are seeing in the commitments enshrined in the Addis Ababa Action Agenda, including the decline in Offi cial Development Assistance, especially to least developed countries, and the growing debt distress of low-income and vulnerable countries. Second, raising ambition on climate mitigation, adaptation and fi nance. Third, making the most of the opportunities that arise from new digital technologies by closing the digital divide and creating decent jobs. Fourth, capitalizing on the growing momentum for sustainable investment among investors, fi rms and savers. This report brings together the latest thinking on these issues from across the international system and presents a wide range of policy recommendations in each of these areas. I hope that it will provide useful guidance to all as we address today’s crisis and embark on a Decade of Action to deliver the Sustainable Development Goals.

António Guterres

iii iv Preface

Mobilizing financing is key to implementing the 2030 Agenda for Sustainable Development. But finance is not an end in itself – it is a means to improve people’s lives and achieve the Sustainable Development Goals (SDGs). Without resources, we cannot meet these goals. Financing is not only about money. Policy and regulatory actions are also necessary both at national and international levels. In 2015, Member States adopted, through the Addis Ababa Action Agenda, a global framework to guide these actions. While significant steps have been made since its adoption, financing remains a major bottleneck. The current global environment, including slow growth and high debt, has compounded financing challenges. The Covid-19 crisis threatens to derail implementation of the SDGs further, with significant human and economic consequences. The international community needs to come together and forcefully act as we progress into the Decade of Action to deliver the SDGs. The new coronavirus underscores the need for global cooperation –to share lessons and solutions, agree on common standards, and help countries most in need. The 2019 High-level Dialogue on Financing for Development, under the auspices of the United Nations General Assembly, showed political will. We must turn this will into concrete actions and raise our ambition. The 2020 Financing for Sustainable Development Report, the fifth report of the Inter-agency Task Force on Financing for Development, provides a comprehensive assessment of the state of sustainable finance. Prepared by more than 60 agencies of the United Nations system and partner international organizations, the report brings together a wide range of expertise and perspectives. It puts forward a set of policy recommendations to mobilize financing flows, and align them with economic, social and environmental priorities. These recommendations should assist Member States and all other stakeholders as they work toward fully implementing the Addis Agenda and achieve the SDGs. Six key messages emerge from this year’s analysis: The global context is difficult; growth remains subpar, with serious downside risks, while high debt levels and rising greenhouse gas emissions exacerbate challenges. Recent trends on several issues are not going in the right direction and need to be reversed. ODA must be increased; trade tensions resolved and investment in the SDGs mobilized. Collective action is crucial as key challenges to sustainable development are global in nature and cannot be addressed by single-country efforts. On the positive side, several MDBs completed successful replenishments, increased lending and further aligned their financing with the SDGs. Digital technologies present tremendous potential for the SDGs, but public policies should be adjusted to accelerate progress, address exclusion and risks of discrimination, and ensure benefits for the society at large, including decent jobs. The private sector gradually realizes that business as usual is not the future and that a transition towards more sustainability is key to the long-term financial success of companies. Policymakers need to support this transition and make financial systems a driver of change.

v 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

The report begins its assessment of progress with an analysis of the global macroeconomic context, which sets the economic framework for implementation eff orts. The subsequent thematic chapter explores how digital technologies are fundamentally changing fi nancing for sustainable development and impacting all action areas of the Addis Agenda. The remainder of the report discusses progress in these seven action areas and data. The report also addresses, throughout the chapters, the seven requests for analysis that Member States made in the outcome of the 2019 FfD Forum. Additional analysis and data are presented in the comprehensive online annex of the Task Force (http://develpomentfi nance.un.org).

Liu Zhenmin Under-Secretary-General for Economic and Social Aff airs United Nations Chair of the Inter-agency Task Force

vi Contents Foreword ��iii Preface ��v Inter-agency Task Force members...... ��ix Overview ��xvii

I. The global economic context and its implications for sustainable development...... ��1 1. Introduction...... �� 1 2. Outlook and risks for the global economy...... �� 2 3. Medium-term challenges: productivity and equity...... �� 8 4. Policies for sustainable development...... �� 11

II. Financing sustainable development in an era of transformative digital technologies...... ��15 1. Introduction...... �� 15 2. The impact of new digital technologies on economies and societies...... �� 16 3. Sustainable financing and development policies for a digital era ...... �� 21

III.A Domestic public resources...... ��37 1. Key messages and recommendations...... �� 37 2. Domestic resource mobilization...... �� 38 3. International tax cooperation ...... �� 43 4. Illicit financial flows...... �� 47 5. Expenditure and strategic procurement in public budgets...... �� 50

III.B Domestic and international private business and finance...... ��59 1. Key messages and recommendations...... �� 59 2. Investment trends...... ��60 3. Private sector development strategies...... �� 61 4. Financial instruments to mobilize private finance ...... ��66 5. Sustainable corporate practices and financial systems ...... �� 71

III.C International development cooperation...... ��81 1. Key messages and recommendations...... �� 81 2. Trends in international development cooperation...... �� 82 3. Public finance instruments...... �� 89

vii 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

4. Graduation and access to concessional finance...... 95 5. Quality, impact and effectiveness of development cooperation...... 98

III.D International trade as an engine for development...... 107 1. Key messages and recommendations...... 107 2. Developments in international trade ...... 108 3. The multilateral trading system ...... 112 4. Bilateral and regional trade and investment agreements ...... 114 5. Facilitating international trade ...... 117 6. Promoting international trade that is consistent with the Sustainable Development Goals in an era of disruptive technologies...... 118

III.E Debt and debt sustainability...... 127 1. Key messages and recommendations...... 127 2. Recent trends in debt burdens...... 128 3. Sustainable and responsible borrowing and lending for the SDGs...... 132 4. Innovative debt instruments...... 136 5. When sovereign debt relief is warranted...... 137

III.F Addressing systemic issues...... 141 1. Key messages and recommendations...... 141 2. International standards of financial regulation...... 142 3. Macroeconomic management and crisis response...... 149 4. Strengthening global governance...... 151

III.G. Science, technology, innovation and capacity-building ...... 157 1. Key messages and recommendations...... 157 2. Measuring progress towards the Addis Agenda in science, technology and innovation. . . . . 157 3. New and emerging technologies and the Sustainable Development Goals...... 163 4. Fintech trends and financial inclusion...... 165 5. United Nations actions on science, technology and innovation...... 169

IV. Data, monitoring and follow-up...... 175 1. Key messages and recommendations...... 175 2. Funding for data for sustainable development...... 175 3. New sources of data and evolving national statistical systems...... 177 4. Progress in strengthening data frameworks, measurements and data collection...... 178 5. Monitoring the financial sector...... 180

viii Inter-agency Task Force members

Task Force coordinator and substantive editor United Nations Department of Economic and Social Affairs (UN/DESA)

Financing for development major institutional stakeholders World Bank Group International Monetary Fund (IMF) World Trade Organization (WTO) United Nations Conference on Trade and Development (UNCTAD) United Nations Development Programme (UNDP) Regional economic commissions Economic and Social Commission for Asia and the Pacific (ESCAP) Economic and Social Commission for Western Asia (ESCWA) Economic Commission for Africa (ECA) Economic Commission for Europe (UNECE) Economic Commission for Latin America and the Caribbean (ECLAC) United Nations system and other agencies and offices Basel Committee on Banking Supervision (BCBS) Committee on Payments and Market Infrastructure (CPMI) Financial Stability Board (FSB) Food and Agriculture Organization of the United Nations (FAO) Global Environment Facility (GEF) Green Climate Fund (GCF) International Association of Insurance Supervisors (IAIS) International Atomic Energy Agency (IAEA) International Civil Aviation Organization (ICAO)

ix 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

International Development Finance Club (IDFC) International Fund for Agricultural Development (IFAD) International Labour Organization (ILO) International Organization for Migration (IOM) International Telecommunication Union (ITU) International Trade Centre (INTRACEN) Joint United Nations Programme on HIV/AIDS (UNAIDS) Office of the High Commissioner for Human Rights (OHCHR) Office of the High Representative for the Least Developed Countries, Landlocked Developing Countries and Small Island Develop- ing States (OHRLLS) Office of the Secretary-General’s Envoy on Youth Office of the Special Adviser on Africa (OSAA) Organisation for Economic Co-operation and Development (OECD) Principles for Responsible Investment (PRI) Secretariat of the Convention on Biological Diversity (CBD) Sustainable Energy for All (SE4All) The Convention on International Trade in Endangered Species of Wild Fauna and Flora (CITES) The Global Alliance for Vaccines and Immunizations (GAVI) UN Capital Development Fund (UNCDF) United Nations Children’s Fund (UNICEF) United Nations Commission on International Trade Law (UNCITRAL) United Nations Convention to Combat Desertification (UNCCD) United Nations Educational, Scientific and Cultural Organization (UNESCO) United Nations Entity for Gender Equality and the Empowerment of Women (UN Women) United Nations Environment Programme (UNEP) United Nations Forum on Forests (UNFFS) United Nations Framework Convention on Climate Change (UNFCCC) United Nations Global Compact (UNGC) United Nations High Commissioner for Refugees (UNHCR) United Nations Human Settlements Programme (UN-HABITAT) United Nations Industrial Development Organization (UNIDO) United Nations Office for Disaster Risk Reduction (UNISDR) United Nations Office for Project Services (UNOPS) United Nations Office for South-South Cooperation (UNOSSC) x INTER-AGENCY TASK FORCE MEMBERS

United Nations Office for the Coordination of Humanitarian Affairs (OCHA) United Nations Office on Drugs and Crime (UNODC) United Nations Population Fund (UNFPA) United Nations Research Institute for Social Development (UNRISD) United Nations University (UNU) United Nations World Food Programme (WFP) World Health Organisation (WHO) World Intellectual Property Organization (WIPO)

xi Abbreviations ADB Asian Development Bank CDB Caribbean Development Bank ADP Advanced Digital Production Technologies CDB Caribbean Development Bank AFAWA Affirmative Finance Action for Women in Africa CDF Caribbean Development Fund AfCFTA African Continental Free Trade Area CEO Chief Executive AfDB African Development Bank CEPII Centre d'Études Prospectives et d'Informations AfDF African Development Fund Internationales AI Artificial Intelligence CERCs Contingent Emergency Response Components AIDS Acquired Immunodeficiency Syndrome CERF Central Emergency Response Fund AIIB Asian Infrastructure Investment Bank CFE Contingency Fund for Emergencies AMC Advance Market Commitment CGD Center for Global Development AML/CFT Anti-Money Laundering and Countering the CITES Convention on International Trade in Endangered Species of Financing of Terrorism Wild Fauna and Flora ARC African Risk Capacity CLO Collateralized Loan Obligation ARDI Access to Research for Development and CMIM Chiang Mai Initiative Multilateralization Innovation COL Concessional OCR Loan ARISE UNDRR’s Private Sector Alliance for COMESA Common Market for Eastern and Southern Africa Disaster-resilient Societies CoP18 The Eighteenth session of the Conference of the Parties ASEAN Association of Southeast Asian Nations COP25 United Nations Climate Change Conferences (2 – 13 ATM Automated Teller Machine December 2019) B2B Business-to-business CPA Country Programmable Aid B2C Business-to-consumers CPMI Basel Committee on Payments and Market Infrastructure BAPA+40 The Second High-level United Nations CPTPP Comprehensive and Progressive Agreement for Trans-Pacific Conference on South-South Cooperation Partnership BBA Bilateral Borrowing Agreements CRS Creditor Reporting System BCBS Basel Committee on Banking Supervision CRW Crisis Response Window BEPS Inclusive Framework on Base Erosion and CSO Civil Society Organization Profit Shifting CSR Corporate Social Responsibility BIS Bank of International Settlements CSTD Commission on Science and Technology for Development BITs Bilateral Investment Treaties CTGAP Cape Town Global Action Plan for Sustainable BSAs Bilateral Swap Arrangements Development Data CACs Collective Action Clauses DAC Development Assistance Committee CAD-CAM Computer-aided Design & Computer-aided Data4Now Data For Now Manufacturing Debt-DQA Debt Data Quality Assessment CAT bonds Catastrophe bonds DeMPA Debt Management Performance Assessment CBDCs Central Bank Digital Currencies DFID United Kingdom Department for International Development CCPs Central Counterparties DFIs Development Financial Institutions CCRIF Caribbean Catastrophe Risk Insurance Facility DGI Data Gaps Initiative xii ABBREVIATIONS

DGI-2 The Second Phase of the Data Gaps Initiative GDPR General Data Protection Regulation DLT Distributed Ledger Technology GFSM Government Finance Statistics Manual DMF Debt Management Facility GFSN Global Financial Safety Net DMFAS Debt Management & Financial Analysis System GFSR Global Financial Stability Report DRM Disaster risk management GHG Greenhouse Gas DRS Debtor Reporting System GISD Global Investors for Sustainable Development Alliance DSA Debt Sustainability Assessment GloBE Global Anti-Base Erosion Proposal DSEP Debt Sustainability Enhancement Program GNI Gross National Income EAC East African Community GPS Global Positioning System EBRD European Bank for Reconstruction and Development GRB Gender Responsive Budgeting ECCB Eastern Caribbean Central Bank GRI Global Reporting Initiative ECLAC United Nations Economic Commission for Latin America and G-SIBs Global Systemically Important Banks the Caribbean G-SIIs Global Systemically Important Insurers ECLAC United Nations Economic Commission for Latin America and GSMA GSM Association (Global System for Mobile Communications) the Caribbean GST Goods and Services Taxes ECOSOC United Nations Economic and Social Council GSTP Global System of Trade Preferences among EDF Environmental Defense Fund Developing Countries EIB European Investment Bank GVCs Global Value Chains EMPEA Emerging Markets Private Equity Association IADB Inter-American Development Bank ESCAP Economic and Social Commission for Asia and the Pacific IADI International Association for Deposit Insurers ESG Environmental, Social and Governance IAEA International Atomic Energy Agency ESRC Economic and Social Research Council IAEG-SDGs Inter-agency Expert Group on SDG Indicators EU European Union IAIS International Association of Insurance Supervisors EY Ernst & Young Global Limited IASB International Accounting Standards Board FACTI Panel High-level Panel on International Financial Accountability, IATT United Nations Interagency Task Team on Science, Transparency and Integrity Technology and Innovation for the SDGs FAO Food and Agriculture Organization IBRD International Bank for Reconstruction and Development FAS Financial Access Survey ICT Information and Communications Technology FATF Financial Action Task Force IDA International Development Association FDI Foreign Direct Investment IDA19 The Nineteenth Replenishment of the International FET Fair and Equitable Treatment Development Association FinTech Financial Technologies IFC International Finance Corporation FMCPI Free Market Commodity Price Index IFF International Finance Facility FMIS Financial Management Information Systems IFFIm International Finance Facility for Immunization FSB Financial Stability Board IFFs Illicit Financial Flows FSDR Financing for Sustainable Development Report IIAs International Investment Agreements FSIs Financial Soundness Indicators ILO International Labour Organization FTAs Free Trade Agreements IMF International Monetary Fund FTT Financial Transaction Tax INFFs Integrated National Financing Frameworks G20 Group of Twenty IoMT Internet of Manufacturing Things GATS The General Agreement on Trade in Services IOPS International Organisation of Pensions Supervisors Gavi Global Alliance for Vaccines and Immunization IOSCO International Organization of Security Commissions GBA+ Gender-based Analysis Plus IoT Internet of Things GCF Green Climate Fund IPF Integrated Policy Framework GDP Gross Domestic Product IPSAS International Public Sector Accounting Standards xiii 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

ISDS Investor-state Dispute Settlement NSOs National Statistical Offices IT Information Technology NSSs National Statistical Systems ITA Information Technology Agreement NTMs Non-tariff Measures ITC International Trade Center OCR Ordinary Capital Resources ITU International Telecommunication Union ODA Official Development Assistance IUU Illegal, Unreported and Unregulated ODI Overseas Development Institute JEDH Joint External Debt Hub OECD Organization for Economic Cooperation and Development KPI Key Performance Indicator P2P Peer-to-peer KYC Know-Your-Customer PARIS21 Partnership in Statistics for Development in the 21st Century LCF Local Currency Facility PBC The People’s Bank of China LDCF Least Developed Country Fund PCRAFI Pacific Catastrophe Risk Assessment and Financing Initiative LDCs Least Developed Countries PCT Platform for Collaboration on Tax LHS Left-hand Side PE/VC Private Equity/Venture Capital LIC DSF Debt Sustainability Framework for Low-Income Countries PEF Pandemic Emergency Financing Facility LICs Low Income Countries PEFA Public Expenditure and Financial Accountability Framework LIDCs Low Income Developing Countries PFM Public Financial Management LLDCs Landlocked Developing Countries PIMA Public Investment Management Assessment LMICs Low and Middle Income Countries PPAs Policy and Performance Actions M&A Mergers and Acquisitions PPI Private Participation in Infrastructure MAC DSA Debt Sustainability Analysis for Market-Access Countries PPP Purchasing Power Parity MAPS Methodology for Assessing Procurement Systems PPPs Public-Private Partnerships MC11 The Eleventh WTO Ministerial Conference PRGT Poverty Reduction and Growth Trust MC12 The Twelfth WTO Ministerial Conference PSD2 Payment Services Directive MCPP Managed Co-Lending Portfolio Program QEDS Quarterly External Debt Statistics MDBs Multilateral Development Banks R&D Research and Development MDG Millennium Development Goals RCEP Regional Comprehensive Economic Partnership Agreement MERCOSUR Southern Common Market RCGs Regional Consultative Groups MICs Middle-income Countries RFAs Regional Financing Arrangements MIGA Multilateral Investment Guarantee Agency RHS Right Hand Side MLI Multilateral Instrument RIAA Responsible Investment Association of Australasia MNEs Multinational Entities RTAs Regional Trade Agreements MOOCs Massive Online Open Courses SASB Sustainability Accounting Standards Board MPA Multi-Pronged Approach SDDS Special Data Dissemination Standard MSMEs Micro- Small and Medium-Sized Enterprises SDFP Sustainable Development Finance Policy MTBF Medium-Term Budget Framework SDGs Sustainable Development Goals MTRS Medium-Term Revenue Strategy SDI Sustainable Development Investing NAB New Arrangements to Borrow SDR Special Drawing Rights NAFTA North American Free Trade Agreement SE Asia Southeast Asia NBER National Bureau of Economic Research SEADRIF Southeast Asia Disaster Risk Insurance Facility NBFIs Non-Bank Financial Intermediaries SEC United States Securities and Exchange Commission ND-GAIN Notre Dame Global Adaptation Initiative SEEA System of Environmental Economic Accounts NGFS Network for Greening the Financial System SEZs Special Economic Zones NGO Non-governmental Organization SIBs Systemically Important Banks NSDS National Strategies for the Development of Statistics SIDS Small Island Developing States xiv ABBREVIATIONS

SIE Small Island Exception UNCAC United Nations Convention against Corruption SIT Sterile Insect Technique UNCITRAL United Nations Commission on International Trade Law SMEs Small and Medium-sized Enterprises UNCTAD United Nations Conference on Trade and Development SMS Short Message Service UNDP United Nations Development Programme SOEs State-owned Enterprises UNECA United Nations Economic Commission for Africa SPR São Paulo Round UNECE United Nations Economic Commission for Europe SPS Sanitary and Phytosanitary UNEP FI United Nations Environment Programme Finance Initiative SSBs Standard-Setting Bodies UNESCO United Nations Educational, Scientific and Cultural SSC South-South Cooperation Organization StAR Stolen Asset Recovery Initiative UNFCCC United Nations Framework Convention on Climate Change STEM Science, Technology, Engineering, and Mathematics UNICEF United Nations Children’s Fund STI Science, Technology and Innovation UNIDO United Nations Industrial Development Organization SWIFT Society for Worldwide Interbank Financial UNODC United Nations Office on Drugs and Crime Telecommunication UNSD Statistics Division of the United Nations Department of TADAT Tax Administration Diagnostic Assessment Tool Economic and Social Affairs TBTF Too Big to Fail UNSGSA Office of the United Nations Secretary-General's Special Advocate for Inclusive Finance for Development TCFD Task Force on Climate-related Financial Disclosures UPI Unique Product Identifiers TCX Currency Exchange Fund URPs Unfunded Risk Participations TFA Trade Facilitation Agreement US United States TFAF Trade Facilitation Agreement Facility USD United States Dollar TFC Trade Facilitation Committee USMCA US-Mexico-Canada Agreement TFM Technology Facilitation Mechanism VAT Value Added Tax TFP Total Factor Productivity VSM Fishing Vessel Monitoring TIPs Treaties with Investment Provisions WBA World Benchmarking Alliance TLAC Total Loss-Absorbing Capacity WBCSD World Business Council for Sustainable Development TOSSD Total Official Support for Sustainable Development WBG World Bank Group TPP Trans-Pacific Partnership WDI World Development Indicators TRAINS Trade Analysis Information System WEO World Economic Outlook TRs Trade Repositories WHO World Health Organization TWI2050 The World in 2050 WIPO World Intellectual Property Organization UMICs Upper-Middle-Income Countries WTO World Trade Organization UN DESA United Nations Department of Economic and Social Affairs 3D Three-dimensional UN/CEFACT United Nations Centre for Trade Facilitation and Electronic Business 5G Fifth-generation wireless

xv OVERVIEW AND KEY MESSAGES Overview and Key Messages

The financing landscape has changed dramatically since the Growing Financial Risks: Short-term financial market volatility adoption of the Addis Ababa Action Agenda. Digital technology has increased due to COVID-19. Prior to that, an extended period has transformed key aspects of financial systems. There has of low interest rates had incentivized riskier behaviour through- also been rapidly growing interest in sustainable investing, in out the financial system. Financial intermediation has steadily part due to greater awareness of the impact of climate and migrated to non-bank financial intermediaries (who hold over 30 other non-economic risks on financial returns. per cent of global financial assets). Yet, just as we begin the decade of action, global challenges have High Debt Risk: Debt risks will likely rise further in the most vul- multiplied. The economic and financial shocks associated with nerable countries. Forty-four per cent of least developed and other COVID-19—such as disruptions to industrial production, falling low-income developing countries are currently at high risk or in commodity prices, financial market volatility, and rising inse- debt distress. That’s a doubling of debt risk in under five years (it curity—are derailing the already tepid economic growth and was 22 per cent in 2015). This number could rise as COVID-19 and compounding heightened risks from other factors. These include related global economic and commodity price shocks put increas- the retreat from multilateralism, a discontent and distrust of glo- ing pressure on some countries, particularly oil exporters. balization, heightened risk of debt distress, and more frequent Increasing Trade Restrictions: Substantial new trade restrictions and severe climate shocks. Together, these make sustainable have been introduced: the trade coverage of import-restrictive finance more difficult—and further undermine the ability to measures are almost 10 times larger than two years prior. The achieve the Sustainable Development Goals (SDGs) by 2030. World Trade Organization’s Appellate Body, meanwhile, no longer Amid these destabilizing trends, the 2020 Financing for has enough members to rule on trade disputes. The COVID-19 Sustainable Development Report of the Inter-Agency Task Force crisis compounds the impact of these restrictions and significantly finds that the international economic and financial systems disrupts trade in goods and services. This crisis also disrupts global are not only failing to deliver on the SDGs, but that there has value chains, with merchandise exports expected to fall by a been substantial backsliding in key action areas. Governments, minimum of $50 billion. businesses and individuals must take action now to arrest these Increasing Environmental Shocks: Greenhouse gas emissions trends and change the trajectory. continue to rise, posing risks to sustainable development. Between 2014–2018, the estimated number of weather-related loss events Arrest the Backslide worldwide increased by over 30 per cent compared to the preced- The unfavourable context identified above is exacerbated by ing five years. the following trends: In this environment, many countries—and especially least developed Slowing economic growth: global growth is expected countries, small island developing States, and other vulnerable coun- to slow markedly in 2020, to significantly below the tries—will not be able to achieve the SDGs by 2030. decade-low growth of 2.3 per cent in 2019, with high risk of a global recession. An urgent priority for the international community is to arrest the backslide. Declining Assistance: Official development assistance (ODA) fell by 4.3 per cent in 2018, and ODA to least developed While many of these issues have deep-rooted causes, there are four countries (LDCs) fell by 2.1 per cent. immediate actions that can help turn the tide: xvii 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

The global community must come together to enhance cooperation Algorithms codify existing biases, such as gender biases in credit and take concerted, forceful, and swift action to combat the impact of screenings. the COVID-19, maintain economic and financial stability, promote trade Digital industries achieve scale and global reach quickly, leading and stimulate growth. Policy responses need to be designed to help to new forms of concentration. Global platforms are acquiring those most in need so that the burden does not fall on those least able significant market power as economic activity is increasingly to bear it. concentrated. Donors should immediately reverse the decline in ODA, particu- Prioritize labour. Current social protection systems may no longer be larly to LDCs. viable in a gig economy where employment relations become more Official bilateral creditors should immediately suspend debt payments precarious. Development pathways can become more challenging, as from LDCs and other low-income countries that request forbearance, new technologies may create fewer jobs. In order to counter these and other creditors should consider similar steps or equivalent ways to trends, countries should pursue labour-enhancing development provide new finance. pathways by incentivizing investment in industries that feature op- Financial instruments, highlighted throughout this report, should be portunities for decent work. implemented and utilized to reduce climate risks and raise resources Keeping a human-centred perspective at the heart of efforts to regulate for SDG investments. digital finance and design of development pathways can ensure that the However, these actions alone will not suffice, and piecemeal approaches whole of society benefits from digital adoption. Sustainable markets will not succeed. Our most intractable challenges—e.g. the increasingly depend on sustainable livelihoods. strained multilateral trading system, debt challenges, climate risks and The report recommends to start with the following actions: other systemic risks—are global in nature and can only be addressed if all 1. Build Basic Digital Access: including in infrastructure and skills; countries come together and work toward common objectives. Collective action remains indispensable. 2. Coordinate Regulation Across Sectors: Regulatory frameworks need to be rewritten and coordinated across sectors—e.g. financial, Accelerate the Transition competition, data security. 3. Cooperate across borders: Multilateral cooperation needs to be As we strive to address these long-standing concerns, the urgency of the strengthened to facilitate experience sharing and capacity support, 2030 Agenda also demands that we take every opportunity to accelerate particularly for LDCs. progress. The Task Force has identified two key trends that can help accelerate the transition toward sustainable finance: (1) the rapid growth of digital technologies and (2) the growing interest in sustainable investing. Second Accelerator: Nurture the growing interest in sustainable Neither of these trends will effectively support the SDGs on their own, investment but with public leadership, supportive public policies, and private sector The approach to human-centred finance should build on the growing engagement, they can help put us on the right trajectory. interest in sustainable investment. Increasingly, business leaders are acknowledging that they must take sustainability factors into account First Accelerator: Harness digital technologies in support of in order to achieve long-term financial success and ensure the viability sustainable finance of their business model. Similarly, individual investors are increasingly The impact of digital technologies is wide-reaching across all the SDGs interested in supporting sustainable finance. However, the tools necessary and on financing for sustainable development through financial markets, to make informed choices are not readily available. Investors are not often public finance, and development pathways. asked about sustainability preferences by their financial advisors, and reliable sustainability metrics and standards are not in place globally to Yet, existing policy and regulatory frameworks are not suited to the properly evaluate and vet potential impact. This needs to change. Volun- new realities. While there is uncertainty as to how digital economies tary actions, which have characterized the sustainable finance industry to will evolve over the next ten years, policymakers do not have the luxury date, are insufficient to achieve the scale of change that is required. Poli- to wait. The national and global policy and regulatory frameworks put cymakers must encourage the growing interest in sustainable investment in place today, and described below, will determine whether digital and help to implement the following three measures. technologies accelerate or reverse progress, particularly with regard to its distributional impact. 1. Adopt Sustainability Risk Disclosures: Policymakers should adopt global mandatory financial disclosures on climate-related financial A new approach is needed to ensure that technological change supports risk. Businesses should also be accountable for broader sustainable implementation of the SDG -- one that prioritizes people. development impacts and required to include common and compa- Prioritize inclusion. Digital technologies can enable inclusion and rable sustainability metrics in their reporting to shareholders and wider access to products and financial services and increase efficiencies, stakeholders. but their impact on inequality must be managed. 2. Establish Sustainability Standards: Regulators should establish Many remain excluded from the digital economy, particularly minimum standards for sustainability information to provide to women and girls. investors for investment products, verifying how and where products xviii OVERVIEW AND KEY MESSAGES

can be marketed on the basis of their contribution to sustainable The remainder of the report (Chapters III.A to III.G and IV) discusses development. progress in the seven action areas of the Addis Agenda. Each chapter 3. Require Sustainability Preference Solicitation: Investment advisors begins with a summary that highlights key messages and presents policy should be required to ask clients about their sustainability preferences, options. The chapters provide updates on implementation and lay out along with information already requested. challenges and policy options on both the national level, including links to integrated financing frameworks (see also Box 1 for an update on the Task The United Nations can support policymakers and business in the imple- Force’s work on integrated financing frameworks), and for international mentation of the above measures. Specifically, the UN can help create a cooperation. They also address the requests made by Member States in the clear understanding of what sustainable investment means, providing intergovernmentally agreed conclusions and recommendations of the 2019 the policymaking and financial community with definitional parameters ECOSOC Forum on Financing for Development. Table 1 lists the issues and within which to set disclosures, metrics and standards. where the related content can be found in this report. Importantly, neither of the previous messages—arresting the backslide and accelerating the transition—are possible without the support of the Box 1: entire international community. Integrated national financing frameworks Aggregate and Advance, Together The Task Force has continued its work on integrated national financing frameworks (INFF), the focus of last year’s thematic The international community needs to take immediate concerted actions chapter. Responding to growing interest from countries, the Task to respond to COVID-19. Governments should coordinate measures at the Force is further developing the INFF methodology, and preparing global level to ensure maximum impact and signal global resolve to main- guidance material. A first module on an INFF inception phase has tain economic and financial stability, promote trade and stimulate growth. been published. Four additional modules (for the building blocks More broadly, implementing sustainable development—whether of operationalizing an INFF: (i) assessment and diagnostics, such as responding to COVID-19, eradicating poverty, reducing inequality, or costings and financing needs assessments; (ii) a financing strategy; combatting climate change—requires every actor, national and subna- (iii) mechanisms for monitoring and review; and (iv) governance and tional, to be on board. As many of these challenges are global, addressing coordination) will be made available later in the year. them requires joint, integrated approaches. Siloed and single-country This material provides guidance to more than a dozen ‘pioneer’ efforts will be insufficient. The current crisis also underlines the need to countries that have expressed interest in implementing INFFs. These strengthen investment in crisis prevention, risk reduction and planning. efforts are supported by UNDP and UN Resident Coordinators, as Experience from responses to past disasters and other hazards underline well as other Task Force members and the European Union. Lessons the need to create adequate crisis-responding financing instruments learned from pioneers inform the methodological work at the before the crisis arrives, building incentives for risk reduction into their global level. design. Postponing such investments increases the ultimate costs to Source: UN DESA the society. International forums to aggregate and align resources and advance collective action exist but remain underutilized. By making use of the ECOSOC Chapter III.A on domestic public resources assesses progress in Financing for Development Forum, and other UN forums, such as the 15th national tax policy and administration, focussing on opportunities UNCTAD quadrennial conference, we can ensure that the whole approach and challenges created by digitalization, as well as international tax to sustainable finance is greater than the sum of its parts. As we work cooperation. Responding to a request by Member States, it dissects the together to creatively solve global challenges, we must continue to pursue various components of illicit financial flows, putting special emphasis on inclusive multilateralism to ensure that no country is left behind in this corruption-related flows. The chapter also discusses how to align fiscal Decade of Action. systems and expenditure with sustainable development. Chapter III.B on private business and finance reviews measures to im- About this report prove the business enabling environment and analyses the use of financial instruments to fill the investment gap in developing countries. The chapter The 2020 Financing for Sustainable Development Report of the Inter-agency also discusses measures to make the financial system more sustainable and Task Force provides a comprehensive assessment of progress in all action companies more accountable for their environment and social impacts. areas of the Addis Ababa Action Agenda. This assessment is grounded in an analysis of the global enabling environment: Chapter I describes a challeng- Chapter III.C on international development cooperation responds to ing global macroeconomic context that is hampering progress. three requests by Member States, including an analysis of: trends in concessional finance; the use of public finance instruments in develop- The thematic chapter (chapter II) explores how digital technologies are ment cooperation, including blended finance; and challenges related to changing financing—including financial sectors, public finance, and graduation. It concludes with a discussion of progress in the development development pathways (trade and investment). The chapter puts forward effectiveness agenda. policy options across the Addis Agenda action areas to make the most of the tremendous opportunities that new technologies create, while care- In Chapter III.D on international trade as an engine for development, fully managing risks. main issues include reforms to preserve and strengthen the multilateral xix 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

trading system, and measures to share the gains from trade more equita- In Chapter IV on data and monitoring, main issues include the new roles bly. This includes support measures to least developed countries, helping of national statistical systems amid a rapidly changing data ecosystem, small- and medium-sized enterprises participate in e-commerce, and and new financing mechanisms for raising resources to meet the data closing trade financing gaps (the latter as requested by Member States in needs of the 2030 Agenda. the 2019 FfD Forum). This Task Force is made up of more 60 United Nations agencies, pro- Chapter III.E on debt and debt sustainability provides an update on key grammes and offices, the regional economic commissions and other debt trends and addresses three key policy issues: debt sustainability and relevant international institutions. The report and its online annex draw on fiscal space for SDG investments; better prevention of debt crises; and their combined expertise, analysis and data. The major institutional stake- progress in the policy agenda around debt crisis resolution. holders of the financing for development process—the World Bank Group, In Chapter III.F on addressing systemic issues, the Task Force updates the International Monetary Fund, the World Trade Organization, the United on implementation of financial regulatory reform and reviews risks to Nations Conference on Trade and Development, and the United Nations financial stability from the non-bank sector. The chapter further discusses Development Programme—take a central role, jointly with the Financing digital currencies, the interrelations between climate change and financial for Sustainable Development Office of the United Nations Department of stability, macroeconomic management and crisis response and institu- Economic and Social Affairs, which also serves as the coordinator of the tional and policy coherence for sustainable development. Task Force and substantive editor of the report. Chapter III.G, on science, technology and innovation complements this The Task Force carried out background research, held dedicated technical year’s thematic chapter, which discusses digital technologies in depth. It meetings, and engaged outside experts to inform this analysis. The report focuses on key quantitative trends in implementing commitments related further benefited from the work of the Intergovernmental Group of Ex- to science, technology and innovation in the Addis Agenda. The chapter perts on Financing for Development, which held its third session in Geneva further discusses several key emerging technologies, including updates on from 25 to 27 November 2019, on the topic of international development fintech, and relevant activities in the UN system. cooperation and interrelated systemic issues.

Table 1 Requests from the 2019 FfD Forum Chapter Workstream Request Domestic public resources Illicit financial flows 2019 Forum outcome (para 12): We request the IATF to report available data on international cooperation on asset return and to devote specific sections of its 2020 report to summaries of channel-specific and component-specific estimates of the volume of illicit financial flows, and the use of technological advances to strengthen tax administration, as well as to combat IFFs. Domestic and international Measurement of 2019 Forum outcome (para 14): We request the IATF to further its analysis on impact and metrics for measurement of the contribution of private business and finance private sector impacts private sector investments and instruments to SDGs at the global level. International development Innovative 2019 Forum outcome (para 16): We invite the IATF, as part of the 2020 Financing for Sustainable Development Report, to assess risks, cooperation instruments opportunities and best practices in relation to different financing instruments, such as blended finance, and how different innovative instruments can be best tailored to the specific situations in developing countries, with special regard to African countries, LDCs, LLDCs, SIDS, and countries in conflict and post-conflict situations, as well as middle-income countries. Graduation 2019 Forum outcome (para 16): We invite the IATF to explore in its 2020 report, building on existing work, the challenges faced by developing countries experiencing diminished access to ODA and concessional finance due to graduation and during transition, as well as recommendations to overcome such challenges. ODA breakdown 2019 Forum outcome (para 16): We also request the IATF, as part of its 2020 report, to continue breaking down the use of ODA in developing countries. International trade as an Trade finance 2019 Forum outcome (para 18): We invite the IATF to continue to monitor developments with respect to trade financing gaps, particularly engine for development for MSMEs, as part of its 2020 report. Science, Technology, Innova- Fourth industrial 2019 Forum outcome (para 24): We look forward to the thematic chapter of the IATF’s 2020 report on financing sustainable development tion and Capacity Building revolution in an era of disruptive technologies and rapid innovation.

THE GLOBAL ECONOMIC CONTEXT AND ITS IMPLICATIONS FOR SUSTAINABLE DEVELOPMENT Chapter I The global economic context and its implications for sustainable development* 1. Introduction

In early 2020, the Inter-agency Task Force on Financing for in industrial production are affecting global value chains Developing (Task Force) members lowered their already tepid and putting additional pressure on already weak trade and growth forecasts due to rapid worldwide spread of COVID-19. investment growth. Economic insecurity and job losses are Even in the most benign scenario, global growth is now impacting consumer demand. Rising volatility in financial expected to slow further in 2020, with a substantial risk of a markets could expose vulnerabilities in some economies global recession. significantly below the decade-low growth of with systemically important financial sectors. Risks of debt 2.3 per cent in 2019.1 The baseline outlook is subject to down- distress in public and private debt—both of which were side risks and uncertainty, including a renewed escalation of already at record-high levels relative to gross domestic trade disputes and a further rise in geopolitical tensions could product (GDP) in developed and developing economies before also affect global growth in the short to medium term. Beyond the crisis—are increasing. The related fall in commodity these risks, the climate crisis continues to pose a rising threat prices (particularly oil prices, which have been aggravated by to economic prospects. Without decisive policy action, there is political tensions) is putting further pressure on debt sustain- a distinct possibility of a prolonged sharp slowdown in global ability in some countries. In Africa, six countries with high economic activity. oil exports could experience significant shocks, while the fall These challenges pose extremely serious risks to the timely in tourism will hurt small island developing States and other implementation of the Sustainable Development Goals (SDGs). tourism-dependent countries. Subdued global growth was already setting back progress To date, monetary policy easing in many systemically important towards higher living standards. Before the outbreak of countries has helped support near-term activity. During periods COVID-19, one in five countries—many of which are home of high uncertainty, monetary policy can boost liquidity to large numbers of people living in poverty—were likely to ensure continued functioning of markets, and support to see per capita incomes stagnate or decline in 2020. This lending. However, monetary policy will be insufficient to number will likely be higher due to economic disruptions from mitigate the economic impact of a global pandemic and restore the pandemic. medium-term robust growth to the world economy. Existing economic vulnerabilities are being further aggravated Swift and forceful policy action is needed in response to COVID-19, by the impact of COVID-19 and related factors. Disruptions drawing on the full policy toolbox—that is, fiscal policy,

* This chapter is based on the following reports: World Economic Situation and Prospects 2020 (United Nations publication, Sales No. E.20.II.C.1); World Economic Outlook, October 2019: Global Manufacturing Downturn, Rising Trade Barriers (Washington, D.C., IMF, 2019); IMF, “World Economic Outlook Update” (January 2020); Trade and Development Report 2019: Financing a Global Green Deal (UNCTAD, United Nations publication, Sales No. E.19.II.D.15); and Global Economic Prospects: Slow Growth, Policy Challenges (Wash- ington, D.C., World Bank, 2020). 1 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

supported by monetary, macroprudential and capital flow management In per capita terms, the global economy grew at a moderate pace of 1.2 policies—according to countries’ fiscal positions and financial vulnerabili- per cent in 2019. This aggregate figure masks stark differences in economic ties. Given the interrelated nature of the global economy, rapid response performance across regions and countries (figure I.2). As economic growth measures should be coordinated at the global level to ensure maximum remains highly uneven across regions, many developing countries have impact and signal global resolve to maintain economic and financial stability, continued to fall further behind. Before the outbreak of COVID-19, aver- promote trade and stimulate growth. Over the medium term, structural age incomes in one out of five countries (predominantly in Africa, Latin and regulatory reforms, public and private investment, and strengthened America and the Caribbean, and parts of Western Asia) were projected to social protection will be important to rekindle growth, address the rapidly stagnate or decline, with more countries expected to see per capita income changing technological landscape, and boost sustainable development declines due to COVID-19. Many of these countries are commodity export- prospects—all of which is discussed throughout the rest of this report. ers. For commodity-dependent developing countries as a group, average annual growth of GDP per capita fell from 2.9 per cent during 2010-2014 to 0.5 per cent in 2015-2019. In one third of these countries (home to 870 2. Outlook and risks for million people), average real incomes are lower today than they were in 2014. These countries are also likely to be significantly hit by the pandemic the global economy outbreak and related commodity price drops. Global prices for soybeans and copper fell approximately 8 and 15 per cent, respectively, between 2.1 Growth trends January and March, while oil prices collapsed in the first half of March (with political issues exacerbating the impact of falling demand). A sustained According to the United Nations World Economic Situation and Prospects drop in commodity prices would severely compound debt and financial 2020, global growth decelerated to 2.3 per cent in 2019, its slowest pace vulnerabilities. since the 2008 world financial and economic crisis, amid weakening trade and investment activity (figure I.1). The growth downturn was broadly Progress towards poverty reduction has slowed in recent years and might based across geographic regions, with about two thirds of countries slow further due to the impact of COVID-19. The number of people living in worldwide recording weaker GDP growth in 2019 compared to 2018. The extreme poverty has risen in several sub-Saharan African countries, where global economy is projected to slow further in 2020, owing to the economic poverty rates are already high. Poverty rates have also edged up in parts of impact of COVID-19 (see box I.1 on COVID-19), before potentially rebound- Latin America and the Caribbean and Western Asia. Growth in most least ing in 2021 (with 2021 forecasts highly dependent on the course of the developed countries (LDCs) remains significantly below levels needed to pandemic and policy response). eradicate extreme poverty by 2030. Only 15 per cent of LDCs are growing at

Figure I.1 Growth of world gross product (Percentage)

DESA 2020 (2010 market exchange rates)

DESA 2020 (2010 PPPs)

4.0

3.8 3.5 3.5 3.6 3.4 3.2 3.2 3.2 3.0 3.0 2.8 2.8 2.9 2.6 2.5 2.5

2.3

2.0 2013 2014 2015 2016 2017 2018 2019e

Source: UN DESA. Note: e = estimate.

2 THE GLOBAL ECONOMIC CONTEXT AND ITS IMPLICATIONS FOR SUSTAINABLE DEVELOPMENT

Box I.1 COVID-19: economic impact and policy options On 11 March 2020, the World Health Organization declared a global pandemica due to the spread COVID-19. At the time of writing, the situation continues to unfold at rapid speed, making it difficult to forecast the global economic impact. Nonetheless, a review of some of the effects on supply and demand, as well as financial and other transmission channels, can help identify critical areas for policy intervention. Unlike typical financial crises, where instability in the financial sector may impact the real economy, COVID-19’s most direct impact is on health and human well-being, with immediate effects on economic activity and jobs, which then feed into the financial sector. COVID-19 affects both the supply and the demand side of the economy, through direct effects (cost of health care, morbidity and mortality) and indirect effects (restrictions of movement and voluntary social distancing). The crisis has already had a significant impact on the economy, including through a disruption of global supply chains; a collapse in travel and tourism; rising unemployment and a decline in consumer demand, a sharp rise in fear and insecurity; and financial market volatility. The pandemic will also strain social systems. Managing the crisis will be particularly difficult for countries with limited fiscal space and weak social protection. Together, these effects are compounding existing financial and debt vulnerabilities (see section 2.4 below). On the supply side, plant closures and a restricted labour supply are impacting global supply chains, trade, investment, and commodity prices. Invest- ment is also likely to fall, as companies delay capital expenditures. For example, China’s manufacturing output and investment contracted significantly in early 2020, with exports falling 17.2 per cent and investment falling 24.5 per cent year on year during January-February.b c On the demand side, restrictions of movement and the cancellation of public events, together with social distancing are affecting the services industry, to date most notably in tourism and hospitality, which will impact a range of countries, including small island developing States. Heightened economic insecurity, including loss of income due to reduced working hours or layoffs (particularly for those without access to a strong safety net), and rising financial losses are likely to dampen consumer spending, in turn further impacting business expectations and investment. Commodity exporters are also expected to be among the countries most affected by the slowdown due to the concurrent fall in commodity prices, particularly oil prices, raising the risk of debt distress for some highly indebted countries. In Africa, six countries with high oil exports could experience significant shocks.d Small and medium-sized enterprises (SMEs) that do not have financial cushions to rely on may struggle to adjust to the demand shock.e There was a significant increase in borrowing by SMEs in the period prior to the crisis in some developed countries. Without relief, there is a high risk of increased defaults by SMEs, as well as by individuals losing that have mortgages or student loans. In early March, global financial markets witnessed large losses and elevated levels of volatility not seen since the onset of the 2008 world financial and economic crisis. Given the highly leveraged nature of the global economy, margin calls may trigger additional sales, leading to a further fall in prices and contagion across asset classes. Developing countries are already experiencing capital outflows, with portfolio outflows from emerging market already surpassing levels observed during the global financial crisis.

Policy options Given the global nature of the pandemic and its economic impacts, the international community needs to take swift concerted actions. Rapid response measures should be coordinated at the global level to ensure maximum impact and signal global resolve to maintain economic and financial stability, promote trade and stimulate growth. In addition, the global community will need to support vulnerable countries that may have limited fiscal space and weak health systems, including through technical support n countries where the virus has not yet manifested. The Group of Seven and Group of Twenty Finance Ministers and Central Bank Governors have signalled their readiness to cooperate. At the country level, increased public health spending, including on screening, supplies, and treatment capacities, can help slow the spread and impact of COVID-19, and have a multiplier effect on the economy. Additional fiscal policy measures can include paid family sick leave, wage subsidies and cash transfers. These are particularly important for the poorest, those without access to health care, and those with precarious employment. Countries may also need to support concessional lending programmes for SMEs. After an initial emergency phase, fiscal policies can also help economic recovery by supporting demand and promoting medium- and long-term sustainable development trajectories (see section 4). This could include increasing public investment and incentives for private investment in sustainable development, to help offset the expected fall in investment due to COVID-19. Short-term policies today also affect future outcomes, so even immediate crisis measures should be aligned with and supportive of sustainable development. The policy response should be sustained, sustainable and equitable, to avoid a rerun of the protracted and slow recovery from the 2008 crisis. In terms of monetary policy, central banks do not have tools to help restore the global supply chains that COVID-19 has disrupted, or support services demand in countries that significantly limit personal mobility. Monetary policy can help counter tighter financial conditions, including through policy

3 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

rate cuts or asset purchases. For example, the ECB has announced a €750 billion Pandemic Emergency Purchase Programme of private and public sector securities, while the Federal Reserve has established additional Dollar-Swap lines with nine more countries to support US dollar funding markets around the globe. Central banks can also provide additional liquidity to financial institutions, particularly by making support conditional on lending to SMEs. Some commercial banks are also developing programmes that allow flexibility or “breathing space” on loan payments for SMEs and individuals feeling financial stress (including for mortgage payments), similar to banks to showing forbearance during natural disasters. And policymakers should consider offering similar flexibilities (e.g. on student loans) along with concessional broad-based lending programmes. Measures should be coordinated at the global level to ensure maximum impact and signal global resolve. Governments will need to eliminate trade barriers and restrictions that affect supply chains. The international community will also need to support countries most in need, which may include a targeted COVID-19 fund, both for humanitarian purposes and to help stop the spread of the global pandemic. The World Health Organization has issued an emergency response plan and donor appeal (see chapter III.C). The IMF is making about $50 billion available through its rapid-disbursing emergency financing facilities, out of which $10 billion are available at zero interest for low-income countries. The Catastrophe Containment and Relief Trust provides eligible countries upfront grants for relief on IMF debt service.f The World Bank also has a number of facilities that countries can potentially access during crises and has announced a $14 billion package of fast-track financing to assist companies and countries affected by COVID-19 (see chapter III.C of this report). These actions will have impact, but more needs to be done. Official bilateral creditors should immediately suspend debt payments from LDCs and other low-income countries that request forbearance, and other creditors should consider similar steps or equivalent ways to provide new finance (see chapter III.E). Source: UN DESA. a WHO, “Coronavirus disease (COVID-2019) situation reports.” Available at https://www.who.int/emergencies/diseases/novel-coronavirus-2019/situation-reports/. b UNCTAD, “Impact of the coronavirus outbreak on global FDI”, Investment Trends Monitor, Special Issue (Geneva, UNCTAD, March 2020). Available at https://unctad.org/ en/PublicationsLibrary/diaeinf2020d2_en.pdf. c Reuters, “China January-February exports tumble, imports down as coronavirus batters trade and business.” Available at https://www.reuters.com/article/us-china- economy-trade/china-january-february-exports-tumble-imports-slow-as-coronavirus-batters-trade-and-business-idUSKBN20U05R. d United Nations Economic Commission for Africa, “Economic Impact of the COVID-19 on Africa.” Available at https://www.uneca.org/sites/default/files/uploaded- documents/stories/eca_analysis_-_covid-19_macroeconomiceffects.pdf. e Blinder, Alan, et. Al., “What can US fiscal and monetary policy do to limit the economic harm from COVID-19?”. Available from: https://www.brookings.edu/blog/upfront/2020/03/10/what-can-u-s-fiscal-and-monetary-policy-do-to-limit-the-economic-harm-from-covid-19/ f Kristalina Georgieva, “IMF Makes Available $50 Billion to Help Address Coronavirus.” Available at https://www.imf.org/en/News/Articles/2020/03/04/sp030420-imf- makes-available-50-billion-to-help-address-coronavirus.

Figure I.2 Average GDP per capita growth by region (Percentage)

1995-2017 2018 2019 5

–1 Eastern Asia South-Eastern Southern Asia Central Asia Eastern Europe Western Asia Sub-Saharan Latin America and Asia Africa the Caribbean

Source: UN DESA.

4 THE GLOBAL ECONOMIC CONTEXT AND ITS IMPLICATIONS FOR SUSTAINABLE DEVELOPMENT a pace close to the SDG target of at least 7 per cent per annum. Eradicating Caribbean, subdued commodity prices continued to weigh on capital global poverty by 2030 will not only require much faster income growth, spending and public investment. The fall in commodity prices in early 2020, but also steep reductions in inequality. For example, even if per capita if sustained, is expected to continue to hinder investment in these income growth for the LDCs were to strengthen to an average annual rate countries. In contrast to developed countries, investment in digitalization of 6 per cent, income inequality would still need to be reduced by half to has remained relatively low in most countries for which data is available eradicate poverty by 2030. (with the exception of China).

Figure I.3 2.2 Impact of trade tensions Global GDP, investment and trade growth, 2005–2019 COVID-19 is also expected to compound already weak international trade (Percentage) and global manufacturing activity (see box I.1). Developed countries 15 Rising tariffs and shifts in trade policies have dampened trade and invest- 10 ment in most regions. The “Phase 1” trade agreement that was reached 5 between China and the United States of America in January 2020 has 0 provided some short-term relief for businesses and investors. Nevertheless, –5 as many of the issues underlying the trade disputes remain unresolved, –10 there is a possibility that trade tensions could re-escalate across countries, –15 although it is unclear whether and how COVID-19 will affect such disputes. –20 Moreover, as more countries resort to unilateralist strategies to resolve 2006 2008 2010 2012 2014 2016 2018 their trade disputes, the World Trade Organization and its rules-based Developing countries multilateral trading system are increasingly being undermined, making 20 multilateral dispute settlements more complex, increasing inefficiencies 15 in global trade and weakening the positions of small and developing 10 countries (see chapter III.D). 5 Renewed pressure on trade would further hurt growth prospects around 0 the world both directly and indirectly. Global value chains could experience –5 more severe disruptions, raising costs and extending the weakness in –10 2005 2007 2009 2011 2013 2015 2017 2019 exports. Persistent high trade policy uncertainty could also prolong the investment slump in many countries. Real investment Real GDP at market exchange rates Real import 2.3 Subdued investment growth Source: UN DESA, based on IMF, World Economic Outlook, October 2019. COVID-19 is also expected to exacerbate already low investment growth prior to the outbreak (see box I.1). Global investment fell in 2019, in tandem with the slowdown in trade flows and industrial production. The 2.4 Monetary policy, leverage, and vulnerabilities fall in investment is most pronounced in developing economies, reflecting On its own, monetary policy cannot address the supply shock related to trends in China as well as other large developing countries (figure I.3). A COVID-19 as central banks do not have the tools to restore disrupted supply prolonged slump in investment activity could also dampen productivity chains or directly support services demand. Monetary policy can help growth, thus affecting both short-term output and medium-term poten- counter tighter financial conditions, but its efficacy is further challenged by tial growth (see section 3.1). the low interest rate environment already in place prior to the outbreak. In developed countries, the decline in investment was, on average, great- Among major developed economies, policy rates have fallen to near zero est in machinery and equipment, and residential real estate. Investment or negative. In 2019, 67 central banks worldwide lowered their key policy growth in intellectual property products held up relatively better and rates (figure I.6), marking the broadest shift in monetary policy since witnessed a strong increase in the United States, possibly reflecting the the 2008 world financial and economic crisis. According to IMF estimates, growth of the digital economy (figure I.4). A related trend in some devel- without this stimulus, global growth would have been 0.5 percentage oped countries may be an increase in market concentration, which would points lower. There are, however, growing concerns that monetary policy lead to lower competition and possibly reduced investment and innovation has reached its limits, particularly in some developed economies. (see chapter II). There are indications of increased financial vulnerability outside the bank- In developing countries, the pace of investment growth varied significantly ing sector relative to historical standards in several large economies with between regions (figure I.5). Trade weakness discouraged export-oriented systemically important financial sectors.2 As illustrated in figure I.7, fewer investment. In a few large emerging countries (e.g., Argentina and Turkey), countries show high vulnerabilities in their banking sectors relative to the the sharp decline in domestic investment reflected ongoing adjustments elevated risk during the 2008 world financial and economic crisis, partly re- to severe macroeconomic imbalances. For commodity exporters, including flecting more stringent regulation (see chapter III.F). However, the share of several economies in Africa, Western Asia and Latin America and the countries with vulnerabilities in non-bank financial institutions increased 5 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Figure I.4 Investment growth in developed economies (Percentage)

Residential Non-residential construction Machinery and equipment Intellectual property products Total 8 United States Canada Germany United Kingdom Australia Japan

–2

–4

–6 2012– 2016– 2018 2019 2012– 2016– 2018 2019 2012– 2016– 2018 2019 2012– 2016– 2018 2019 2012– 2016– 2018 2019 2012– 2016– 2018 2019 2015 2017 Q1–Q3 2015 2017 Q1–Q3 2015 2017 Q1–Q3 2015 2017 Q1–Q3 2015 2017 Q1–Q3 2015 2017 Q1–Q3

Source: UN DESA, based on data from national authorities. Note: Data for Germany, Japan and the United Kingdom are total investment, data for Australia, Canada and the United States are private investment.

Figure I.5 Growth of gross xed capital formation in developing regions (Percentage) 2012–2015 2016–2017 2018 2019

–2

–4 Southern Asia Eastern Europe Eastern and Africa Western Asia Latin America and and Central Asia South-Eastern Asia the Caribbean

Source: UN DESA, based on data from national authorities. 6 THE GLOBAL ECONOMIC CONTEXT AND ITS IMPLICATIONS FOR SUSTAINABLE DEVELOPMENT

Figure I.6 Figure I.7 Monetary policy shifts Proportion of systemically important economies with (Number of central banks) elevated nancial vulnerabilities, 2007–2008 and 2019 (Percentage of countries with high and medium-high Eased Tightened vulnerabilities, by GDP [assets for banks]; number of countries in parentheses) 70 Other nonbank 60 nancials 100 Sovereigns (18) (10) 80 50 60 More vulnerable 40 40 20 Insurers Non nancial 30 (11) rms (15) 20

10 Banks (8) Households 0 (15) 2015 2016 2017 2018 2019 October 2019 GFSR April 2019 GFSR Source: Central Bank News Global nancial crisis Note: Sample covers 95 central banks.

by almost 20 percentage points during the second half of 2019 alone, to Source: IMF, Global Financial Stability Report, October 2019 reach levels similar to those before the crisis. Also, significantly more countries than before the crisis show high levels of vulnerability of sovereigns Figure I.8 and of the non-financial corporate sector (figure I.7) (see chapter III.E). Breakdown of non- nancial sector debt of developed and emerging economies Public and private debt have risen to record-high levels relative to GDP in (Percentage of GDP) both developed and developing economies (figure I.8). High sovereign debt could be a growing source of risk to financial stability for some de- Government Corporates Households veloping countries. Between 2010 and 2019, interest payments as a share 300 of government revenue increased in more than 70 per cent of developing countries—despite historically low yields—and 44 per cent of least 250 developed and other low-income countries are currently considered to be in debt distress or at high risk of falling into debt distress (see chapter III.E). 200 In developed countries, corporate debt has increased since 2011, surpassing pre-crisis levels (after an initial decline following the 2008 world financial and economic crisis). In large developing countries and emerging 150 economies, the ratio of corporate debt to GDP has risen by 31 percentage points since 2011, with government and household debt ratios each 100 growing by over 15 percentage points. Yet, much of the financing raised by corporate borrowing has been used for share buybacks, to pay out 50 dividends and boost short-term investor returns, or to fund mergers and acquisitions, rather than for productive investments.3 0 While the growth in corporate debt in some countries (e.g., China) is con- 2007 2011 2019 2007 2011 2019 centrated in larger firms, including state-owned enterprises, in others (e.g., Developed economies Emerging economies the United States) it is more pronounced in smaller and medium-sized companies (SMEs). As COVID-19 is expected to have a particularly large Source: Bank for International Settlements, Total Credit Statistics. impact on SMEs (see box I.1), the risk of corporate default has increased Note: 2019 refers to outstanding debt data as of 2Q 2019. Advanced economies significantly in these countries. comprise Australia, Canada, Denmark, the euro area, Japan, New Zealand, Norway, Sweden, Switzerland, the United Kingdom and the United States. Emerging market “Lower for longer” interest rates also create incentives that lead to riskier economies comprise Argentina, Brazil, Chile, China, Colombia, the Czech Republic, behaviour in the financial system. For example, institutional investors that Hong Kong SAR, Hungary, India, Indonesia, Israel, Korea, Malaysia, Mexico, Poland, Russia, Saudi Arabia, Singapore, South Africa, Thailand and Turkey. 7 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

are less risk averse increasingly purchased high-yield bonds. At the same global risk aversion and widening credit spreads due to the impact of time, the average credit quality of debt has fallen. In the United States, COVID-19 (see box I.1). even for corporate bonds rated “investment grade,” the share of triple-B rated bonds (the lowest “investment grade” bonds) in outstanding debt 2.5 Risks from other non-economic factors: climate change has increased. Potential sell-offs in the case of downgrades and rising credit spreads—which could arise from the COVID-19 pandemic—could While it is hard to predict the further spread and duration of the COVID-19 have systemic implications, as the mandates of many investors forbid them pandemic, its economic impact is being felt strongly across the globe. from holding bonds with sub-investment grade credit ratings. These Beyond the immediate threat, climate change and other natural hazards effects can be exacerbated if the investments were initially funded are posing an increasing risk to the short, medium and longer-term eco- through borrowing (see also box I.2). nomic outlook. Between 2014 and 2018, the number of weather-related loss events worldwide is estimated to have increased by over 30 per cent Box I.2 compared to the preceding five years.4 Climate shocks inflict significant Rising leverage and loosening underwriting standards and long-lasting damage, including loss of income, destruction of physical and human capital, and widening inequalities. As shown in figure I.7, vulnerabilities are elevated in the non-bank While the estimated overall cost of disasters in 2019 ($150 billion) was financial sector in a number of countries (what was formerly called lower than in the preceding three years, there were many events with “shadow banking”). For example, “leveraged loans” (loans to higher losses in the low billions. This highlights the volatile nature of annual risk corporate borrowers usually syndicated to multiple lenders, most losses, as statistics are often dominated by large individual events.5 of which are then packaged into “collateralised loan obligations”,) Nonetheless, an estimated 68 per cent of losses during 2005-2017 were have doubled in volume since the crisis, to reach $1.2 trillion in caused by small and medium, localized and frequent disasters.6 Although 2019.a In addition, financial institutions have loosened underwriting rebuilding efforts provide a temporary boost to economic growth, they standards and issued loans with fewer covenants that have tradition- also divert scarce resources away from other development needs. Debt ally protected lenders in loan contracts. More than 80 per cent of levels inevitably rise as governments borrow to finance recovery efforts, new leveraged loan issues in the United States of America have been driving up borrowing costs and further burdening public budgets. “covenant-lite”.b Business development companies—closed-end investment companies that invest in small- and medium-sized en- Climate-related risks are also increasingly affecting the financial sector. As terprises (SMEs)—have also experienced a weakening in covenants. risk evaluations of assets change, insurers and banks may be exposed to As discussed in the chapter III.B of this report (private finance), if well large losses that could impact financial stability. While addressing climate structured, diversified and regulated, such instruments could support change will take a wide range of policy measures, an increasing number the Sustainable Development Goals by raising new financing for of central bank governors have acknowledged the need to respond to SMEs. However, there are also some inherent risks in many of these the risks it poses to the financial sector. In 2019, the Network of Central types of structures (see chapter III.B) that tend to have additional Banks and Supervisors for Greening the Financial System published a set leverage built in to enhance their yield. Perhaps one of the biggest is of guidelines that urges peers to price climate change risk when regulating the tendency for underwriting standards and covenants to weaken financial companies, and to invest with sustainability goals in mind for during periods of high liquidity. As these loan instruments are traded their own portfolios (see chapter III.F).7 internationally, there is a risk of systemic implications on global Some central banks governors do not consider climate change to be as rel- financial markets and spillovers, depending on the nature of their in- evant for monetary policies, since they expect only limited effects on their ternational financial linkages. This underscores the need to continue own countries’ GDP growth and inflation in the near term. There is also no to strengthen regulatory frameworks for non-bank financial activity consensus on the role of central banks’ own portfolios in supporting green (see chapter III.F of this report). investment. For instance, the US Federal Reserve and the Bank of Japan Source: UN DESA. consider this outside their mandates, while the Bank of England and the a Based on S&P/LSTA Leveraged Loan Index. European Central Bank have indicated strong interest in such policies.8 The b S&P Global, “US leveraged loan default rate hits 9-month high as market Bank for International Settlement launched a green bond fund in 2019, as distress rises.” Available at https://www.spglobal.com/marketintelligence/ en/news-insights/latest-news-headlines/55929866. an option for central banks to include environmental sustainability objectives in their reserve management.9

The systemic impact of this credit growth depends in large part on the interlinkages of the investment products and portfolios and the financial system. Risks can be amplified due to leverage, as fund managers might 3. Medium-term challenges: be forced to sell other assets to raise money to cover their losses and repay productivity and equity debt, leading to contagion across markets with systemic implications. There is a risk that financial market volatility associated with COVID-19, including widening credit spreads and falling asset prices, could trigger 3.1 Recent trends in labour and total factor productivity such sales, putting further pressure on financial markets. Developing The recent investment slump has caused a slowdown of capital countries are also facing the risk of capital flight triggered by increasing deepening,10 reinforcing a longer-term trend of slowing productivity

8 THE GLOBAL ECONOMIC CONTEXT AND ITS IMPLICATIONS FOR SUSTAINABLE DEVELOPMENT growth in many developed and developing countries. Indeed, all major financial and economic crisis, and more recently the increase in global developed economies have experienced a downward trend in labour trade tensions and policy uncertainty. productivity growth over the past three decades (figure I.9). The growth Although average labour productivity continues to grow significantly of total factor productivity (TFP) (the efficiency with which capital and faster in developing economies, most have also experienced a marked labour are used together for production) has also slowed. Notably, pro- slowdown compared to the decade before the 2008 world financial ductivity growth from ICT investment seems to have resisted the overall and economic crisis. This has been mainly due to a sharp downturn in downward trend over the past two decades , albeit without significantly total factor productivity growth, suggesting less dynamic economic boosting total productivity (see also chapter II). transformation processes and slowing gains from trade integration. Both structural and near-term factors may explain why expectations Aggregate figures mask stark differences among the various regions; of rapid productivity gains from new digital technologies have not yet notably, as illustrated in figure I.10, there is a large gap between East materialized at an economy-wide scale in developed economies (box Asia and South Asia and the other developing regions. Weak investment I.3). Structural factors that have affected productivity growth since the and slow productivity growth in Western Asia, Latin America and the late 1990s and early 2000s include demographic shifts, relative growth Caribbean, and sub-Saharan Africa do not bode well for medium-term of the service sector, slowing gains in education and gender equality, a economic development prospects. Without strong structural policy slower pace of trade integration and innovation,11 and a slowing rate measures to boost productivity, including large-scale infrastructure of technological diffusion (the speed at which technological innovations investment, improvements to the quality of education and promotion of spread within and across economies).12 These longer-term factors have innovation capacity, rapid progress towards the SDGs will remain elusive been exacerbated by the decline in investment since the 2008 world in many countries.

Figure I.9 Labour productivity growth in developed economies (Percentage)

Labor quality Total factor productivity ICT capital Non-ICT capital Labor productivity growth 4.0

3.0

2.0

1.0

–1.0

–2.0 1991–2000 2001–2010 2011–2015 2016–2018 1991–2000 2001–2010 2011–2015 2016–2018 1991–2000 2001–2010 2011–2015 2016–2018

Japan United States Western Europe

Source: UN DESA, based on data from The Conference Board Total Economy Database. Note: Regional growth rates are weighted by real GDP.

9 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Box I.3 Slow productivity growth in times of rapid technological advances: the productivity paradox High expectations for the transformational potential of digital technologies contrast sharply with the downward trend in productivity growth in developed economies over the past few decades. Neither the digital revolution that began in the 1980s nor the more recent advancements, including progress in artificial intelligence and machine learning, have fundamentally changed this trend. This apparent disconnect between rapid technological advancements and slowing productivity growth is known as the “productivity paradox”. Many potential explanations, which are not mutually exclusive, have been put forward:a (i) output, and therefore productivity, may be undercounted in national statistics; (ii) technological progress and its diffusion may be slower than expected; and (iii) increasing market concentration due to the nature of the digital economy has weakened investment and, therefore, productivity. In addition, spending patterns and employment have also been moving away from tangible goods to services (childcare, health care, education), where productivity growth tends to be slower. National accounts may undercount output for two main reasons: First, many new technology firms provide “free goods”—such as free navigation systems or social media networks—and “better goods”—such as better phones, media and communications services, and software. Without prices that reflect the value of these “free” and “better” goods, national accounts will continuously underestimate their contribution to economic output. Second, national accounts may severely underestimate investments, as the capital stock is increasingly shifting towards intangible assets—such as patents, branding and managerial knowledge, which are much harder to quantify than tangible assets. Nonetheless, these measurement problems are not new and do not seem to have become significantly larger over time. They are thus unlikely to account for a large part of the observed productivity slowdown.b Regarding the nature and speed of technological progress and its diffusion, some recent studies have raised doubts about whether the current wave of innovations will have the same economy-wide effects as technological breakthroughs of the past. Some argue that the age of great invention may be essentially over, and the pace of technological progress will likely continue to slow.c Others stress that new ideas are simply harder to find and that an ever-increasing number of researchers are required to maintain a given rate of growth in productivity.d As discussed in chapter II, increasing market power may have also contributed to the observed productivity slowdown by reducing competition and, with it, the need to invest and innovate. Where this is due to the “winner take most” nature of the digital economy, technical progress would be self-defeating, as potential productivity gains would be undermined by its effects on market concentration.e However, others argue that the rise in market power is mainly due to higher entry barriers in many sectors as a result of mergers and acquisitions, lobbying, and regulatory capture.f Other economic and structural factors have also contributed to current productivity headwinds, as discussed in chapter II. While no single narrative can provide a full explanation, a better understanding of the productivity puzzle in different country contexts can help improve policies to support future productivity growth, as a key contributor to sustainable development. Source: UN DESA. a See for example Gustavo Adler and others, “Gone with the Headwinds: Global Productivity”, IMF Staff Discussion Note 17/04 (April 2017); and Ian Goldin and others, “The Productivity Paradox: Reconciling Rapid Technological Change and Stagnating Productivity”, Oxford Martin School Programme on Technological and Economic Change (April 2019). b David Byrne, Stephen Oliner and Daniel Sichel, “Prices of High-Tech Products, Mismeasurement, and Pace of Innovation”, NBER Working Paper No. 23369 (April 2017); Chad Syverson, “Challenges to Mismeasurement Explanations for the US Productivity Slowdown”, Journal of Economic Perspectives, Volume 31, Number 2 (Spring 2017), pp. 165–186; Ian Goldin and others, “The Productivity Paradox: Reconciling Rapid Technological Change and Stagnating Productivity”, Oxford Martin School Programme on Technological and Economic Change (April 2019); and Thomas Philippon, “How America Gave Up on Free Markets” (Cambridge, The Belknap Press of Harvard University Press, 2019). c Robert J. Gordon, “The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War” (Princeton, Princeton University Press, 2016). d Nicholas Bloom and others, “Are Ideas Getting Harder to Find?”, NBER Working Paper No. 23782 (September 2017). e David Autor and others, “The Fall of the Labor Share and the Rise of Superstar Firms”, Quarterly Journal of Economics, 135-2 (Forthcoming, 2020). f Thomas Philippon, “How America Gave Up on Free Markets”.

3.2 Impact of technological changes on wages While a decrease in the labour share has been documented for a majority and profit shares of countries since the early 1980s,14 trends in wage inequality vary by countries and regions. Wage inequality has risen significantly in most The documented slowdown in average labour productivity growth—par- developed countries over the past decades, with the bulk of the increase ticularly visible in developed economies—has hurt workers by limiting occurring in the 1980s and 1990s, driven mainly by a widening gap the potential for real wage growth. This trend has often been accom- between top and median wage earners. Among developing regions, wage panied by two other developments: (i) a decline in the labour share of inequality has risen in many East Asian countries, while Latin America and income, reflected in a growing gap between labour productivity growth the Caribbean and parts of Africa have experienced some decline in wage and real average wage growth; and (ii) rising wage inequality, reflected inequality in recent decades. in a growing gap between real average wage growth and real median wage growth.13 Although not as prominent in developing countries, there is also a risk of future job losses or job polarization, owing to automation and digital 10 THE GLOBAL ECONOMIC CONTEXT AND ITS IMPLICATIONS FOR SUSTAINABLE DEVELOPMENT

Figure I.10 Labor productivity growth in developing and transition economies (Percentage)

1991–2000 2001–2010 2011–2015 2016–2019 8 7 6 5 4 3 2 1 0 –1 –2 –3 East Asia South Asia Western Asia Latin America and Sub-Saharan Commonwealth of the Caribbean Africa Independent States

Source: UN DESA, based on data from The Conference Board Total Economy Database. Note: Regional growth rates are weighted by real GDP. technologies (see chapter II). Up to now, technological progress has been for Sustainable Development, and overall progress in reducing gender identified as an important driver of the growing gap between productivity gaps has been slowing.17 While women have been catching up in basic and median wages. In developed economies, a technology-driven decline capabilities—through access to education, voting rights, and the removal in the price of investment goods has induced firms to substitute capital for of legal barriers—progress has been much slower when it comes to more labour, thus lowering the labour share.15 enhanced capabilities that involve greater power and responsibility as well 18 Technological change has also contributed to the rise in wage inequality, as political and economic leadership. Women account for about 60 per as it is a complementary input to the work of highly skilled workers but a cent of contributing family workers worldwide (generally not receiving substitute to that of low- or medium-skilled workers. The latter may be monetary compensation). COVID-19 may further impact gender equity— made redundant or receive relatively lower wages. However, other factors for example, through mass school closures that lead to additional childcare have also played an important role—from increasing trade integration work, and other unpaid care work that is still predominantly carried out by 19 and expansion of global value chains, which has particularly hurt some women. Women make up only a very small part of the highest-paying 20 21 lower-skilled workers in developed countries, to losses in the bargaining jobs, and only about 18 per cent of firms worldwide are led by women. position of workers, owing to declining labour union membership and a Eliminating gender inequalities requires a wide range of policy measures, shift towards more non-standard employment. in both developed and developing countries. In many countries, there is still room for further legal reforms, as well as increased transpar- 3.3 Gender equity ency, financial incentives (e.g., linked to cash transfer programmes) and programmes aimed at changing women’s and men’s attitudes.22 Trade Wage inequality also continues to be an important aspect of gender inequali- unions, together with Governments, business, and employers’ organiza- ty. Globally, the gender pay gap—which measures the percentage difference tions can take a number of actions to tackle gender pay gaps—such as in pay between men and women—is estimated at about 20 per cent, with mainstreaming the principle of equal remuneration, awareness-raising, 16 important differences across country groups. In developed countries, the and targeted action, in addition to increased representation of women in gap is generally more pronounced at the upper end of the income distribu- decision-making bodies.23 tion, as effective minimum wage policies reduce the gap at the lower end. In developing countries where a large share of female employment is in the informal sector, the gap is larger at the bottom. These differences in pay for the same work are further exacerbated by opportunity gaps, with women 4. Policies for often encountering challenges to move to more senior roles. sustainable development As highlighted by several recent reports, the world is not on track to achieve Policymakers need to mitigate the short-term risks of COVID-19, without the gender goals of the Addis Ababa Action Agenda and the 2030 Agenda losing sight of medium- and long-term structural issues. This will require

11 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

an immediate, concerted, global response to the crisis (see box I.1), along two years (figure 11) and the imperative of the current economic and with a balanced policy mix for the medium term that draws on the full public health crisis caused by COVID-19 requires significant and widespread toolkit of economic policies. short-term fiscal easing. The experience after the 2009 fiscal stimuli Short-term actions also affect medium-term outcomes, so it is important is a lesson for a more measured pace and content of fiscal adjustment that any crisis response take into account longer-term impacts and be after the COVID-19 crisis eases. Fiscal expenditures and revenues have aligned with sustainable development. Task Force members have called an important role to play in the structural transformation of developing for fiscal policy to play a more proactive role in supporting demand, countries. Sustainable development requires prioritizing public investment particularly in countries where fiscal space exists. Macroprudential in sustainable and resilient infrastructure, enhancing redistributive policies, policies will also be important, especially in countries with high financial and strengthening social welfare systems. Public investment, along with vulnerabilities. Capital flow management can help countries with large incentives for private investment, will also be needed to help counteract balance sheet mismatches mitigate the impact of capital flow volatility the fall in investment due to COVID-19. These should be aligned with (see chapter III.F). In addition, strengthened social protection systems, im- sustainable development. proved risk management (see chapter III.C) and structural and regulatory Integrated national financing frameworks can help national policy plan- reforms can support medium- to long-term growth prospects—taking ning by supporting resource mobilization and allocation within the context into account the growing importance of the digital economy (see of an enabling international environment. Rapid technological innovation chapter II). creates new opportunities for both domestic and international finance In many developing countries (outside East Asia), high levels of debt and to support the achievement of the SDGs. Public policies can contribute to ongoing fiscal pressures limit the room for countercyclical policy measures. harnessing these opportunities, while mitigating risks, as discussed in However, fewer countries have been tightening fiscal stances in the past chapter II.

Figure I.11 Fiscal policy stances (Number of countries) Large easing Small easing Small tightening Large tightening 80

0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Source: IMF, World Economic Outlook Database October 2019. Note: Small easing/tightening is de ned as a change in the structural scal balance of less than 0.5 per cent of GDP. Large easing/tightening is greater than 0.5 per cent of GDP.

Endnotes 1 World Economic Situation and Prospects 2020, p. viii. The 2.3 per cent growth in 2019 is based on at-market exchange rates. When adjusted for purchasing power parity (PPP), global output is estimated to have risen by 2.9 per cent. These figures are broadly in line with the estimates by other Task Force members. The Global Economic Prospects reports global growth of 2.4 per cent based on at-market exchange rates, and the “World Economic Outlook Update”, which uses PPP, reports 2.9 per cent. 2 Global Financial Stability Report: Lower for Longer (Washington, D.C., IMF, 2019), p. 6. 12 THE GLOBAL ECONOMIC CONTEXT AND ITS IMPLICATIONS FOR SUSTAINABLE DEVELOPMENT

3 Ibid. 4 Munich Re, NatCatSERVICE analysis tool. Available at https://www.munichre.com/en/solutions/for-industry-clients/natcatservice.html. 5 Munich Re, “Tropical cyclones cause highest losses: Natural disasters of 2019 in figures.” Available at https://www.munichre.com/topics-online/en/ climate-change-and-natural-disasters/natural-disasters/natural-disasters-of-2019-in-figures-tropical-cyclones-cause-highest-losses.html. 6 UNDRR, “Global Assessment Report on Disaster Risk Reduction” (Geneva: UNDRR, May 2019), p. 251. Available at https://gar.undrr.org/report-2019. 7 Network for Greening the Financial System, “First comprehensive report: A call for action,” (April 2019). Available at https://www.ngfs.net/en/ first-comprehensive-report-call-action. 8 Willem H. Buiter, “When central banks go green.” Available at https://www.project-syndicate.org/commentary/ central-banks-go-green-by-willem-buiter-1-2020-01. 9 BIS, “BIS launches green bond fund for central banks.” Available at https://www.bis.org/press/p190926.htm. 10 The term “capital deepening” refers to an increase in the proportion of capital to labour. It is often measured by the rate of increase in capital stock per labour hours worked. 11 Gustavo Adler and others, “Gone with the Headwinds: Global Productivity”, IMF Staff Discussion Note 17/04 (April 2017); and Global Economic Prospects: Slow Growth, Policy Challenges. 12 Dan Andrews, Chiara Criscuolo and Peter N. Gal, “Frontier Firms, Technology Diffusion and Public Policy: Micro Evidence from OECD Countries”, The Future of Productivity: Main Background Papers, (Paris, OECD, 2015). 13 OECD Economic Outlook 2018, Issue 2, Chapter 2: Decoupling of Wages from Productivity: What Implications for Public Policies? (Paris, OECD, 2018) shows that while there are large cross-country-differences, such a decoupling occurred in two thirds of the 24 countries examined. 14 Loukas Karabarbounis and Brent Neiman, “The Global Decline of the Labor Share”, The Quarterly Journal of Economics, Volume 129, Issue 1 (February 2014), pp. 61–103; and World Employment and Social Outlook: Trends 2020 (Geneva, International Labour Organization, 2020). 15 A decline in relative investment prices will only reduce the labour share if the elasticity of substitution between capital and labour is greater than 1. Recent empirical evidence suggests that this has generally been the case for developed economies in recent decades, but not for developing economies. 16 Global Wage Report 2018/19: What Lies Behind Gender Pay Gaps (Geneva, International Labour Organization, 2018). 17 Global Wage Report 2018/19: What Lies Behind Gender Pay Gaps; Human Development Report 2019: Inequalities in Human Development in the 21st Century (UNDP, United Nations publication, Sales No. E.20.III.B.1); Global Gender Gap Report 2020 (Geneva, World Economic Forum, 2019); and World Social Report 2020: Inequality in a rapidly changing world (United Nations publication, Sales No. E.20.IV.1). 18 Human Development Report 2019: Inequalities in Human Development in the 21st Century. 19 Rosamond Hutt, “The coronavirus fallout may be worse for women than men. Here’s why” World Economic Forum, (March 2020). Available at https://www. weforum.org/agenda/2020/03/the-coronavirus-fallout-may-be-worse-for-women-than-men-heres-why/ 20 In many developing countries, a large share of female employment is in the informal sector. 21 Global Gender Gap Report 2020. 22 Seema Jayachandran, “The Roots of Gender Inequality in Developing Countries”, Annual Review of Economics, Vol. 7:63-88 (August 2015). 23 Jill Rubery and Mathew Johnson, “Closing the Gender Pay Gap: What Role for Trade Unions?”, ILO ACTRAV Working Paper (April 2019).

13 FINANCING SUSTAINABLE DEVELOPMENT IN AN ERA OF TRANSFORMATIVE DIGITAL TECHNOLOGIES Chapter II Financing sustainable development in an era of transformative digital technologies 1. Introduction

Digital technologies have come into much sharper focus thematic chapter of the Financing for Sustainable Development since 2015, impacting the main areas of finance and devel- Report 2020 presents policy options across all action areas of opment highlighted in the Addis Ababa Action Agenda: (i) the Addis Agenda to harness the potential of digital technolo- financial markets; (ii) public finance; and (iii) development gies for the benefit of people, ensuring that gains are shared pathways (trade and investment). widely and risks are managed carefully, and that national Digital technologies create tremendous opportunity for actions are supported by collective global measures. achieving a more sustainable financial system that supports Several key recommendations emerge from the analysis in the Sustainable Development Goals (SDGs). The promise of this report: digital technologies is clear: they can enable inclusion and Take a strategic approach to digital finance to provide a wider access to products and services and increase efficien- common frame of reference for all actors. This can take cies, particularly in the financial sector and in public financial different forms—as part of a science, technology and management. They can also strengthen societal resilience to innovation (STI) strategy or road map, a dedicated digital crises. During the COVID-19 outbreak, digital communication economy strategy, or explicit integration of digital tech- tools help sustain human interaction and continuity in some nologies in the broader planning process (e.g., embedded in vital economic activities, although many developing countries a country’s integrated national financing framework); do not have such capacities, putting them at a disadvantage. Put basic building blocks in place today to participate in But like similar transitions in previous eras, rapid technologi- the digital economy, including (i) prerequisite infrastruc- cal change also causes “growing pains” and the emergence of ture; (ii) digital skills; and (iii) updated enabling regulatory new risks. How quickly and effectively policies and regulatory and policy environments; frameworks adjust will determine their contribution to sustainable development. Revisit policy frameworks and the regulatory architecture to respond to the cross-cutting and wide-ranging effects of Currently, our institutions and policy frameworks are often ill digital technologies on financing. Silo-style regulation will equipped to address new risks, such as the growing dominance not be viable when digital technologies, information and and market power of big tech firms across sectors and national communications technology (ICT), data, finance, and other borders. In some sectors and countries (e.g., payments in sectors interact in myriad ways; China, financial inclusion in East Africa), digital technologies are causing rapid and dramatic change; in others, impacts are much Maintain a level playing field to ensure that the entry of more gradual or uncertain. How frontier digital technologies players that harness the power of big data leads to innova- will evolve over the next ten years, and how they will affect tion and diversification rather than market domination (e.g., inequality, jobs, and development pathways, remains unclear. big tech in the financial sector). Digital technologies should benefit people not just as consumers, but also in their role However no country, and no financing and economic policy as producers and workers; domain, will remain entirely unaffected. While policy solutions will always be context specific and depend on a country’s Identify labour-enhancing development pathways unique circumstances, all countries must get ready today to be to pursue structural transformation while avoiding to prepared for an increasingly digital economy of tomorrow. This incentivize the adoption of labour-replacing digital 15 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

technologies when creating decent jobs is a major policy challenge. and services (see box II.1 for an overview of key digital technologies). Some Preparing for the digital age can be pursued in parallel to supporting have called digital technologies inherently inclusive due to the unique labour-enhancing development pathways, in a two-pronged approach; properties they possess.1 Furthermore, by enhancing efficiency, digital Step up global collaboration on digital technologies and finance to technologies can also be an enabler for sustained,more sustainable and 2 create spaces for peer learning among policymakers and regulators, to resilient growth, decarbonization, and resource and energy efficiency. For strengthen capacity support, and to facilitate coordinated responses, example, during the COVID-19 outbreak, remote communication technolo- such as global guidelines and standards. gies enabled the preservation of essential human interactions and thus prevented the complete cessation of economic activity. The next section of this chapter lays out the challenges and opportunities that digital technologies create for sustainable development. It traces these Some changes resulting from digital technologies are gradual and almost to the unique properties of digital technologies (an almost costless flow of imperceptible, while others are sudden and obvious. There are countless unprecedented amounts of data, which lowers transaction costs and can examples across all 17 SDGs where digital technologies are already making 3 help overcome inefficiencies linked to information failure) and describes their a difference. In the financial sector, digital technology is being lever- impacts on financial and product markets. The third section puts forward aged to facilitate payments, intermediation and risk management, with financing policy and institutional responses across the action areas of the important implications for the poor and underserved. In public financial Addis Agenda to achieve the SDGs. This section examines the basic building management, they help deliver programmes more effectively and reduce blocks of a digital economy, and the three highlighted areas of finance and leakages. In manufacturing and services, digital technologies are changing development: financial markets, public finance and development pathways. the nature of production and work. Their ability to address sustainable development challenges is of course not limitless; digital technologies are not a panacea. Many people remain 2. The impact of new digital excluded from the digitalized economy (box II.2 spells out how the terms “digital” and “digitalized” economy will be used in this report). Impacts on the technologies on economies distribution of income and opportunities are highly ambiguous. Furthermore, digital technologies have not led to less resource-intensive growth patterns. and societies Indeed, uncertainty over viable sustainable development pathways abounds. Questions arise across all three dimensions of sustainable development: 2.1 Which opportunities and challenges do digital What will be the jobs of the future? What are viable development technologies create for sustainable development? pathways in the digital era? Digital technologies can be a key lever for achieving the 2030 Agenda Are we heading for an era of inclusion and opportunity, or will the digi- for Sustainable Development and leaving no one behind. Ranging from tal and data divide further increase inequalities and discrimination? technologies that have become ubiquitous, such as mobile phones, to frontier technologies like artificial intelligence (AI), they offer the promise Will digitalization dematerialize production and reduce our environ- of greater access for more people to an ever-widening array of products mental footprint, or will increased energy use caused by digitalization outpace potential energy savings?

Box II.1 What are the key digital technologies? Technological innovation has been the main driver of long-term growth and prosperity over the last 200 years. Transformative general-purpose technologies, such as electricity or the internal combustion engine, have fueled global growth of gross domestic product. Each of these technologies spawned a wealth of innovations that, once economies and societies had fully adjusted, lifted living standards for the vast majority.a Digital technologies, which build on the storage and processing of information represented in bits, were first developed after the Second World War. Software and hardware industries have grown rapidly ever since, but for much of the twentieth century, their impact remained limited. It was only with the rise of the Internet in the 1990s, which enabled computer-to-computer communication at low cost, that multiple markets and sectors were impacted, and digital technology became a new, general-purpose technology.b Increased connectivity has been a defining feature of digital technological progress over the last three decades. Today, devices and people routinely share enormous amounts of data, leaving rapid, real-time trails of information behind. Building on this ubiquity of digital data and increasing computa- tional power, recent years have seen the emergence of several closely linked digital frontier technologies:c Cloud computing refers to shared pools of hardware comprised of computer networks, servers, data storage and applications software that can be rapidly mobilized through the Internet. Cloud computing minimizes fixed costs for hardware and other complementary investments. Companies using cloud services by third-party providers such as Amazon, Google, Microsoft, IBM, Alibaba and others are billed according to storage space and computer run time. They do not have to shoulder the full costs of acquiring, setting up, and operating hardware and software; The diffusion of smartphones and other Internet connected devices has facilitated aggregation of big data sets that underlies the implementation of digital technologies. With the advent of cloud storage, very large data sets can be conveniently stored, accessed and analysed on a massive

16 FINANCING SUSTAINABLE DEVELOPMENT IN AN ERA OF TRANSFORMATIVE DIGITAL TECHNOLOGIES

scale. Superfast computers can use big data to discern patterns and predict trends, which can aid decision-making in areas ranging from finance to aero-engine maintenance; Artificial Intelligence (AI), which includes machine learning and deep learning, is at the leading edge of digital technology. A new crop of algorithms and the availability of much greater computing power is enabling machines to learn from the examples and experience captured in big data. For example, a deep learning algorithm for a self-driving car must recognize vehicles, pedestrians and cyclists, in all hours of the day and in all weather conditions. With the help of thousands of images, the nested set of algorithms for neural networks conceptualizes the image of a vehicle. Once trained, the network can identify any vehicle with a high degree of probability. The utility of neural networks extends to robo-investment, credit analysis and other areas; With 5G networks, greater interconnection and improved edge computing devices, the Internet of Things (IoT) and the Internet of Manufacturing Things (IoMT) is likely to flourish. AI-enabled computers the size of a credit card are already installed in vehicles, in machinery and infrastructures to monitor conditions, signal problems and trigger a response; Distributed ledger technology (DLT) is a database technology that allows the creation, storage and secure transfer of information. Often referred to as blockchain, this technology stores records of information across distributed computers. DLT can be public (permissionless), in which case all participants have the exact same role, or private (permissioned), where some participants have specific rights, such as the ability to accept new participants or audit the ledger. a Shahid Yusuf, “Development Pathways in the Context of New and Emerging Digital Technologies” (2019). Background paper prepared for this report. b Avi Goldfarb and Catherine Tucker, “Digital Economics”, Journal of Economic Literature, vol. 57, Issue 1 (March 2019), pp. 3-43. Available at https://doi.org/10.1257/ jel.20171452. c Adapted from Yusuf. 2019.

Digital technologies, jobs and growth Digital technologies and inclusion Concerns about the digital economy are greatest around jobs. Estimates Because digital technologies provide goods and services at dramatically of future job losses due to automation and AI vary widely, ranging from reduced cost, they have facilitated the inclusion of marginalized and a low of 5 to 10 per cent to almost half of all existing jobs.4 So far, the excluded people. Financial inclusion is the most prominent example and widespread introduction of digital technologies has not led to a rise in signature success story, with fintech playing a key role in the rapid growth unemployment. There is, however, evidence that digital technologies of access to financial services globally (see chapter III.G). Yet, the impact of have contributed to greater wage inequality in developed countries, as digital technologies on equity is ambiguous. Access to digital technologies routine and manual jobs have disappeared, with those affected by job remains very uneven. While over three quarters of the world’s population losses forced to accept lower-skilled and lower-paying jobs (e.g., in services is likely to have access to or own a mobile phone, only half is using the industries)5 (see chapter I on the global context). Internet. The gender gap in Internet use is growing in Africa and in least 11 While most analysis of automation focuses on developed countries, developed countries (see also chapter III.G). developing countries are also affected. Developing countries’ comparative Digital technologies may also exacerbate inequality and discrimination, as advantage of low-cost labour may erode.6 Automation could reduce the algorithms inherit biases from their human authors, or as AI is developed potential of the manufacturing sector (and some services) to absorb the with data that contains a history of bias and discrimination. Algorithms large number of workers, including youth, that enter the labour force each and AI—ranging from ranking job applications, deciding who qualifies year.7 So far, evidence of adverse effects of automation in developing for insurance and more—have serious implications, including on gender countries is limited, but this may change over time. This raises the question equality and women’s empowerment. For example, fintech lenders, whether traditional development pathways that focus on labour-intensive informed by algorithmic decision-making, have been found to charge manufacturing exports are still viable. interest rate premiums to minority communities,12 while advertisements These questions are mirrored in what is sometimes called the “produc- for high-paying jobs are disproportionally targeted at men. Popular voice 13 tivity paradox”. On the one hand, the accumulation of ICT capital and assistants are commonly coded as female by default. digital technologies contributes to global growth of gross domestic Furthermore, access to more advanced production technologies remains product. Mobile broadband penetration and digitalization is essential for highly unequal. Far from making geographical location irrelevant, eco- regional economic growth in developing countries in particular.8 On the nomic activity related to digital technologies is increasingly concentrated other hand, expectations of rapid income and productivity growth are in a few urban areas with good infrastructure and, especially, access to a not yet matched by hard evidence. This may reflect excessive optimism large pool of highly skilled workers. This contributes to a self-reinforcing regarding digital technologies’ transformative potential,9 or mismea- mechanism that increases the concentration of opportunity, income and surement, or merely a time lag until such potential is fully realized. wealth. Geographic concentration of value capture in the digital economy Indeed, historically, major new technologies have taken decades to also extends beyond borders: the two largest economies alone, the United have measurable effects10 (see also box I.3 in chapter I). At this point, States of America and China, account for 97 per cent of market capitaliza- there is uncertainty over the medium- and long-term growth impacts of tion of platforms valued at more than $1 billion globally (72 and 25 per digitalization. cent, respectively).14

17 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Box II.2 The digital and digitalized economy: on terminology Digital technologies impact all sectors of the economy. In line with other recent major United Nations reports, this chapter differentiates between the following: The core digital sector, responsible for developing and providing key digital technologies (for example, cloud computing and artificial intelligence); The digital economy, or “that part of economic output derived solely or primarily from digital technologies with a business model based on digital goods or services,”a which includes a broader range of activities that create economic value through the application of these technologies (for example, digital platforms and digital services); and The digitalized economy, which describes wider structural implications of digitalization for the economy as a whole.b a Rumana Bukht and Richard Heeks, “Defining, Conceptualising and Measuring the Digital Economy”, ESRC Development Informatics Working Papers Series No. 68 (2017). b J. Scott Brennen and Daniel Kreiss, “Digitalization”, The International Encyclopedia of Communication Theory and Philosophy (23 October 2016). . Figure II.1 Conceptual overview of the digital economy

Broad Scope: Digitalised Economy

Narrow Scope: Digital Economy

Core: Digital (IT/ICT) Sector

e-Business

e-Commerce Digital services Industry 4.0 Hardware manufacture Sofware & Platfrom Precision IT consulting economy agriculture

Infomation Telecommunications Algorithmic services Sharing economy economy

Gig economy

Source: Bukht & Heeks (2017), UNCTAD (2019).

Digital technologies and the environment Before analysing financing policy and institutional responses that can help ensure that digital technologies contribute to sustainable finance Digitalization holds the prospect of dematerialization of production, and achieving the SDGs (section 3), it is first necessary to understand the and thus of more sustainable growth patterns. This is because more unique properties that characterize digital technologies. services can be provided digitally, and because “smarter” production and distribution systems can enhance efficiencies—for example, with respect to energy use (box II.3). At the same time, digitalization dramati- 2.2 What are the economic properties of digital cally increases energy use. So far, this demand-effect far outstrips any technologies? other effects on sustainability. Digital technologies were responsible for Digital technology has dramatically reduced the costs of storing, process- 2.5 per cent of global greenhouse gas emissions in 2013, and this share is ing and transmitting data. As a result, it has made unprecedented amounts predicted to increase to 4 per cent in 2020 and 8 per cent in 2025, mostly of economically relevant information available to economic agents, such as 15 due to increases in energy consumption. digital data collected from the footprints of personal, social and business 18 FINANCING SUSTAINABLE DEVELOPMENT IN AN ERA OF TRANSFORMATIVE DIGITAL TECHNOLOGIES

Box II.3 Digital technologies and energy use Digital technologies, and especially new networked and artificial intelligence (AI) applications, are rapidly emerging as important drivers of change in energy systems and for energy demand.a Internet-connected digital technologies and “smarter” energy systems (e.g., smart heating controls) will play an important role in transitioning to a more sustainable and energy efficient economic system. Yet, energy savings may be concentrated, or even outweighed by the high energy use of many digital innovations. For example: The energy footprint of all smart phones per average year of use was 30 per cent larger than that of passenger cars in 2015, and this gap is expected to continue to grow in line with more rapidly increasing numbers of smart phones;b Online video streaming is on the same order of magnitude as air transport in terms of energy use and CO2 emissions (1.0 and 2.5 per cent of global CO2 emissions, respectively). Video streaming on mobile phones is vastly more energy consuming, with 5G expected to further increase overall power consumption;c Algorithms rely on vast amounts of data that are stored in data centers. Bottom-up estimates for data centers’ energy use in 2030 range from between a five-fold increase (from 200 to 1,000 TWh) to a fourteen-fold increase to roughly 4,900 TWh. Traditional government energy policies, such as electricity market reform and price incentive schemes, are needed to support the development of new services and devices that are energy-efficient or energy-saving. Government-backed, long-term research and development on novel materials, devices and new computing architectures including quantum computing can further help to reduce power consumption of digital technologies and AI systems.d a Roehrl Richard, “Exploring the impacts of artificial intelligence on the global energy system”, SLP/TFM Research Paper (December 2019). Available at https:// sustainabledevelopment.un.org/index.php?page=view&type=12&nr=3335. b Vaclav Smil, Energy and Civilization: A History, (Cambridge, Massachusetts, The MIT Press, November 2018). c Chris Preist, Daniel Schien and Paul Shabajee, “Evaluating Sustainable Interaction Design of Digital Services: The Case of YouTube”, in Proceedings of CHI Conference on Human Factors in Computing Systems Proceedings (Glasgow, Scotland UK, May 2019). d Klaus Fichter, “E-commerce: sorting out the environmental consequences”, Journal of Industrial Ecology, vol.6, Issue 2 (08 February 2008), pp. 25-41. activities on mobile phones, social media and the Internet (see also box II.4 Digital goods represented in bits can be reproduced at essentially zero on the data economy). cost (economies of scale in economic terms) and can be consumed over Analogous to previous periods of technological change, digital technolo- and over again (i.e., they are non-rival in consumption). Additional gies impact economic activity in two broad areas: users often increase the value of digital goods for existing users (network effects), which can lead to large firms and greater market They facilitate a more effective exchange or flow of information, concentration. Digital firms can thus grow quickly and obtain large goods and services. Companies have access to relevant economic and market shares and achieve vast scale without mass. financial information, can more easily reach customers, coordinate suppliers, and organize their operations. This is similar in impact to the contributions made by railways, shipping containers, telegrams and 2.3 How do digital technologies affect market structures similar innovations in the past;16 and business models? They increase efficiency and lower the cost in the production of goods The properties described above find their reflection in market outcomes. and services. Digitalization allows companies to save on raw materials, Digital technologies lower production costs and prices. In a digitalized energy, storage space, time and labour. Information and communica- economy, firms might find it easier to access new markets. But this has not tions technology, robots and other digital technologies play the same always led to more competition. Instead, market concentration is growing role that the spinning jenny or the steam engine played in previous in many sectors, particularly in the digital economy itself where global industrial revolutions. platforms play a dominant role. So how are market structures and business models affected? Why digital is different First, lower prices are a key benefit of digital technology. For example, in Digital technologies also possess several unique properties that qualita- the media industry, most products are now sold in digital format, so that tively change how goods and services are produced and, in some cases, the cost of production and distribution of additional items (the marginal change market structures.17 They include cost) is almost zero. In the financial sector, digital technology can lower Information, search and transportation costs that are close to zero. the cost of financial services, including credit, and expanding its reach Unprecedented amounts of data can be collected because digital to the previously unbanked. In sectors where goods and services are still activity is easily recorded and activities can be tracked. This can help delivered physically, key components in the value chain—such as design, to overcome information-related market failures—in finance, for marketing, back-office work, or logistics management—can be digitized example. Searching for information is also cheaper, helping consumers and provided at reduced cost. Technologies such as AI facilitate analysis to discover a wider variety of goods and supplies, and firms to access of vast amounts of data and solve increasingly complex problems. As a new markets; result, a growing number of tasks previously performed by humans can be 19 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Box II.4 The data economya Digital data has become an increasingly important input for the production of goods and fi nancial and other services. Companies have learned to harvest and ext ract valuable information from vast amounts of data and turn it into an asset of signifi cant value. The data value chain begins with data collected from individuals and connected devices in the Internet of Things. Aggregators and custodians store and organize the data, making it accessible and marketable. Algorithms analyse and extract useful information. Data presenters then translate the results into insights for their clients. Data giants like Amazon leverage the entire data value chain. They capture data from both consumers and their production chain, organize and analyse the data, and extract insights.

Figure II.4.1 The data value chain

Capture data Store and organize Analyze Report Expand into new functions Internert of Things Harmonization Analytics package Visualization

API for sharing data Big Data Machine learning User interface Data science and development Investigation and New sources Algorithm development Cloud providers discovery

Expand into new stages

Source: UN DESA elaboration based on Opher and others., 2016.

The data economy is growing in size; it represents 1.0, 0.8, and 0.5 per cent of gross domestic product (GDP) of the United States of America, Japan and the European Union, respectively. It also generates much larger indirect and secondary economic eff ects. In the European Union, for example, the total impact of the data market on the region’s economy in 2017 was €336 billion, or 2.4 per cent of total GDP. This is because the data increases the value of upstream industries that can monetize it. How value is generated in the data economy has important distributional, privacy, ethical and public policy implications. Data-driven industries are highly concentrated. Access to detailed personal data increasingly allows companies to charge each customer diff erent prices. The collection and use of personal data, designed to infl uence behavior, also carries with it a potential for abuse. With a few large fi rms dictating the terms and conditions of data availability and use (as well as capturing the profi ts), the data economy can further exacerbate income and wealth inequality, and even impact the security and stability of political systems. a Based on Hoi Wai Jackie Cheng, Marcelo LaFleur and Hamid Rashid, “Data Economy: Radical transformation or dystopia?”, UNDESA Frontier Technologies Quarterly (New York: United Nations Department of Economic and Social Aff airs, January 2019). Available at https://www.un.org/development/desa/dpad/wp-content/uploads/ sites/45/publication/FTQ_1_Jan_2019.pdf.

automated. This includes increasingly non-routine and cognitive tasks that costs for micro, small and medium-sized enterprises (MSMEs) in develop- were once long beyond the remit of machines.18 ing countries, the Internet has expanded their access to global markets.20 Second, digitalization technologies can lower entry barriers and present Cheap reproduction and easier search and matching of actors mean that opportunities for fi rms, including those in developing countries, to access geographic boundaries become much less relevant. larger markets. The Internet, cloud-based computing, and open software Third, online platforms have emerged as important new forms of drastically reduce the need for major investments in software and services. intermediation. Platform-centred businesses have a major advantage in Even cutting-edge technologies such as AI can now be rented by fi rms in the data-driven economy. They can record and extract all data related to both developed and developing countries by the hour through cloud-based online actions and interactions among their users. This data can then be computing platforms. In many sectors, the main non-labour costs of a monetized, for example, by selling targeted online advertising, operating start-up are a laptop computer and an Internet connection, together with e-commerce platforms, renting out cloud services, or allowing consumers cloud-based computing services and/or a 3D printer.19 Digital technolo- and/or fi rms to share their underutilized assets (the sharing economy).21 gies’ impact reaches beyond the core digital economy: by reducing export Thanks to network eff ects (a product or service gains additional value as 20 FINANCING SUSTAINABLE DEVELOPMENT IN AN ERA OF TRANSFORMATIVE DIGITAL TECHNOLOGIES

more people use it), online platforms can grow and gain market share externalities. This requires, before all else, investment in the basic building very quickly. blocks that enable participation in the digital economy. Seven of the world’s top eight companies by market capitalization use Putting basic building blocks in place: investing in infrastructure and platform-based business models. Google has about 90 per cent of the skills to be digital-ready (Addis Agenda action area G, on science, technol- global market for Internet searches. Facebook accounts for two thirds of ogy, innovation and capacity-building, and data) the global social media market. Amazon boasts an almost 40 per cent share The basic building blocks of a digital economy—infrastructure, Internet of the world’s online retail activity. In China, Alibaba has been estimated access, digital skills and regulatory and data policies—ensure that indi- to have close to 60 per cent of the Chinese e-commerce market. WeChat viduals and firms are connected to and can function in the digital world. (owned by Tencent) has more than one billion active users and, together But providing access alone is not enough to address new opportunities and with Alipay (Alibaba), its payment solution has captured virtually the entire risks in financial markets, respond to new challenges and opportunities in Chinese market for digital payments. Such platforms can eliminate interme- public finance, and chart viable development pathways. The remainder of diaries and rent-seekers, enhancing market efficiencies. At the same time, the chapter will look at policy and institutional responses across the action global digital platforms have taken steps to consolidate their competitive areas of the Addis Agenda, clustered in three broad financing areas: positions, which may end up slowing down economic dynamism and pre- cluding developing-country platforms from reaching competitive scale.22 (i) The financial sector: How is fintech changing financial markets across payments, savings and credit, and risk management? Will fintech Fourth, market concentration is growing across industries and countries, make access to financial services more or less equitable? What are despite lower entry barriers. “Winner take most” mechanisms have the challenges, such as to financial stability, and what are the policy become more common even beyond the core digital economy, and digital options? (Addis Agenda action areas B, on private business and technologies are partly responsible. A small number of so-called superstar finance; E on debt and debt sustainability; and F on systemic issues); firms have increased their productivity (and profits), as increasingly complex technologies require evermore sophisticated complementary (ii) Public finance: How can policymakers use digital technologies to investments and highly specialized skills in the workforce, while the major- enhance public financial management efficiency and combat illicit ity of firms, even in the same industry, have lagged behind.23 financial flows, while adapting tax and expenditure policies to a digitalizing economy? (Addis Agenda action area A); and (ii) Development pathways: How is the developmental model chang- 3. Sustainable financing and ing? What investment, trade and technology policy options exist to find development pathways in the context of digitalization? (Addis development policies for a digital era Agenda action areas B, on private finance and investment, C on in- Changing business models and market structures demand a compre- ternational development cooperation, D on trade, and G on science, hensive rethink of financing and development policy and regulatory technology, innovation and capacity building). approaches. Digital technologies Affect all parts of society and economy, hence any policy responses 3.1 Becoming digital-ready need to be mindful of their impacts across traditional industry bound- Closing digital gaps requires investments in physical infrastructure, afford- aries, policy domains and on various stakeholders; able access, digital skills and data. Are complex and highly technical, so that no one actor is likely to have sufficient knowledge and information to make informed decisions; Digital infrastructure Are evolving rapidly, so that experiences with new technologies are Affordable connectivity remains a challenge, particularly in least devel- often limited and uncertainty over future developments is high. oped countries and remote regions. Digital infrastructure is one of the basic preconditions for affordable access to the Internet. It ranges from For this reason, countries should take a strategic, whole-of-society approach, the point where the Internet enters a country, such as submarine cable which engages all relevant stakeholders, and can solicit relevant informa- landing stations or satellite dishes (the first mile), the national backbone tion, raise awareness and provide a common frame of reference for all infrastructure, such as a national and intercity backbone network (the actors.24 This is reflected in the Addis Agenda, where Member States com- middle mile), to local access networks that connect users (the last mile), as mitted to “adopt science, technology and innovation strategies as integral well as non-visible components such as data and data centres, spectrum, elements of our national sustainable development strategies”. In practice, and others (the “invisible mile”).25 these strategic responses can take different forms—as part of an STI strategy or STI road maps, a dedicated digital economy strategy, or through Developing such broadband networks requires significant investment. the explicit integration of digital technologies in broader planning processes Both public and private investments are usually needed to create and (e.g., embedded in a country’s integrated national financing framework). maintain high-quality ICT infrastructure. Markets are most likely to deliver this infrastructure closest to the end user, particularly in cities, The concrete elements of these strategies will vary depending on each where ICT infrastructure investments often have a positive financial individual country’s stage of development and its respective involvement return. Public sector involvement is often necessary in the first and middle in the creation and use of digital technologies. Since technological change miles. Public involvement will also likely be necessary to close most of the is a key source of growth and sustainable development, all countries remaining gaps in broadband network infrastructure, which tend to be in need to exploit its potential while being mindful of any possible negative 21 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Figure II.2 Financing policy responses to the digital revolution – a strategic approach

Use digital technologies for achieving the SDGs:  for inclusive, stable and long-term oriented nancial Adapt nancing policies and systems institutions:  for enabling sustainable growth  nancial market regulation paths  public nancial management  for achieving equitable Put in place basic building and taxation outcomes blocks:  the 'real economy': investment,  STI and complementary trade, technology and related infrastructure policies  regulatory frameworks  digital skills

Source: UN DESA. geographically or economically challenging areas, such as rural areas in Complementary Infrastructure developing countries (box II.5).26 The most important complementary infrastructure is reliable access to Internet exchanges, data centres and cloud computing and hosting affordable energy, since significant electricity is required to power the ICT services are a hidden—or non-visible—component of digital infrastruc- sector (box II.3). The projected energy demand to support a future digital ture. This core Internet infrastructure is vital to developing a local Internet economy needs to be taken into account in countries’ energy infrastruc- ecosystem. For example, if national data centres have limited capacity, and ture investment plans. Traditional connectivity also matters for digital data and cloud computing applications are hosted abroad, there could be trade, as high trade logistics costs (e.g., transport costs caused by poor significant cost implications as well as vulnerabilities. infrastructure) hamper participation in the broader digitalized economy— a particular challenge for landlocked developing countries. In e-commerce, Box II.5 logistics account for 26 per cent of final prices for MSMEs in developing Financing mechanisms to enable broadband countries, on average—almost double the share in developed countries.27 infrastructure projectsa Enabling policy frameworks and regulation Broadband infrastructure projects, particularly the development of national backbone infrastructure, are capital-intensive projects. A Connectivity can also be hampered by excessive market concentration, combination of financing mechanisms is often used to support the mismanaged privatizations, and other factors. Digital policy and regula- roll-out of infrastructure installation; they include equity financing, tory frameworks need to be reviewed to address such challenges. Key but usually investment credit offered by the public and private bank- interventions for policymakers and regulators include the establishment ing market represents the most important financing mechanism. of national broadband plans, open access and infrastructure sharing, or requirements of major infrastructure providers to include the provision of Access to the private investment credit market depends on economic optical fibre.28 viability of the infrastructure project. As ICT prices have fallen, operators in many countries have experienced falling average revenues per As digital technologies become pervasive and have impacts across all user. But the telecommunications industry remains generally profit- sectors, regulators are grappling with and have to address an increasingly able, even if margins are lower than a decade ago. However, when complex set of challenges. Traditional silo-style ICT sector regulation is national backbones are extended to underserved areas (e.g., areas that unlikely to prove viable for much longer. Because digital infrastructure, are geographically remote, have low population density, or are poor), services and content are relevant across industries and national borders, public support will often be needed. Direct subsidies can be made the existing regulatory architecture needs to be revisited. For example, the available, for example, through universal service obligation funds cre- International Telecommunication Union has noted the development of a ated specifically to foster telecommunication development, or through more holistic approach to ICT regulation—referred to as the 5th genera- specific tax exemptions applied to operators who engage in the tion of regulation—which could enable regulators to collaborate with project. Indirect subsidies include (i) the lowering of spectrum licensing other sectors, such as finance, in harmonizing regulation for the entire fees in exchange for a commitment to deploy and provide service in ICT ecosystem. This regulatory approach is collaborative and involves less profitable areas or (ii) converting an operator fines backlog into consulting Governments, regulators from different sectors, market actors obligations to deploy and provide broadband services in these regions. and consumer associations, and enhancing adaptive capacity to support effective response to rapidly changing contexts and market behaviour. a Based on ITU, Infrastructure business planning toolkit 2019.

22 FINANCING SUSTAINABLE DEVELOPMENT IN AN ERA OF TRANSFORMATIVE DIGITAL TECHNOLOGIES

Digital skills: education and training policies clarifies what companies that process personal data must do to safeguard these rights. Several countries outside the EU have since introduced Lack of digital skills is a major obstacle to greater access to and use of measures aligned with the EU approach, and several major ICT corpora- digital technologies. This skills gap, along with affordability, is often the tions are applying a standardized approach globally.34 Similarly, the primary reason individuals and households as well as firms do not use California Consumer Privacy Act specifies new consumer rights relating the Internet. In a survey of more than 2000 MSMEs in 111 countries, firms to the access to, deletion and sharing of personal information collected noted lack of technical skills as the second-most important challenge for by businesses. e-commerce participation.29 Privacy and security demands have to be balanced with the objective of Curricula in schools and universities can be adapted to include digital creating value from data and supporting innovation. Economic value literacy, including basic digital skills as compulsory elements, along with stems from pooling and analysing large amounts of individual data. more advanced ICT-related skills (e.g., coding). Digital skills education for Controlling access to large data sets grants individual firms a competitive women and girls needs to be accelerated rapidly to establish more women advantage that could entail a barrier to market entry for competitors and as digital creators. lead to market concentration. Data ownership regulations can help address Digital technologies in turn can contribute to more effective learning these issues by defining who can access, use and delete data.35 To share outcomes. Ed-tech, which applies ICT to improve education (e.g., through economic value more widely, several alternative ownership mechanisms computer-assisted learning or online learning), can also strengthen stu- are being considered. These range from personal data markets, where dents’ digital skills. Blended programmes and computer-assisted learning, users are given ownership rights over their own data, to collective data such as games, can be particularly effective in this context.30 While digital ownership, where data is treated as a public resource.36 There could be technologies are allowing more children access to learning, especially in several different models of collective ownership. In an extreme case, data remote regions and during humanitarian crises, many miss out. About could be owned by public authorities. Alternatively, public authorities 29 per cent of youth worldwide – around 346 million individuals – and could regulate how data is accessed, used and deleted without assuming 60 per cent of African youth are not online, compared with just 4 per cent ownership. “Data subject rights” grant individuals a range of specific rights, in Europe.31 including the right to access, the restriction of processing, and data porta- Digital skills training should also be part of professional development bility. For example, the EU Payment Services Directive allows customers to programmes and technical and vocational training. Effective technical transfer data to third-party providers to facilitate a level playing field for and vocational programmes can play an essential role in strengthening market contestants. job-specific digital skills. Experience suggests that targeted programmes— those focusing on women or long-term unemployed, for example—are Digital identity likely to yield greater results, and that the involvement of businesses Digital identity systems, which allow people to be authenticated through 32 allows for programmes that are better aligned with firms’ needs. Digital a digital channel, have been introduced in a number of countries. They skills might be most effectively acquired through on-the-job training. can significantly increase access to financial services, public services and Governments could also incentivize this in different ways, such as through benefits. This can also benefit education and other key SDG areas, and 33 tax rebates or co-financing schemes. thus help unlock key benefits of digital technologies.37 Such systems rely Countries are experimenting with new models to support ICT skills devel- on the basic infrastructure discussed above to be in place. Risks related to opment. For instance, Rwanda is employing young Rwandans as “digital data privacy and protection, or exclusion of those that do not have digital ambassadors” who are trained in ICT and soft skills and then provide identity, need to be addressed. training on using the Internet and other ICT technologies throughout the country, including in rural communities. Bangladesh has set up thousands 3.2 Financial markets, macro and systemic issues of Union Information Service Centers, which offer access to the Internet along with training. Financial markets play a central role in allocating resources in the economy and fueling economic growth. Yet, at the same time, the history of Data policies financial markets has been marked by volatility, boom and bust cycles, and financial crises, often impacting other sectors, jobs and livelihoods. People National data policies are necessary to protecting the essential rights of and firms can lack access to financial services, including both deposits and individuals and companies and unlocking the economic opportunities that credit, and thus be excluded from full participation in the economy. lie in collecting, sharing and analysing individual data. Many of these problems are driven by information failures—either Effective legislation that addresses data privacy and security for missing information or unequal access to information (asymmetric consumers and firms is not yet in place in many countries. A recent information). For example, there is a clear relationship between market development in this area is the General Data Protection Regulation(GDPR) herding and uncertainty.38 Because digital technologies translate data in the European Union (EU), which defines standardized data protection into unprecedented amounts of financially relevant information, they have laws for all member countries and lays down the rules relating to the the potential to improve the efficiency of markets and facilitate access for processing of personal data by an individual, company or organization, previously excluded or underserved populations. Yet, digital technologies including the transfer of personal data outside the EU. The GDPR makes also create new challenges. The effect of digital technologies on financial it easier for EU citizens to understand how their data is being used and stability, integrity and equity are highly uncertain.

23 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

The different functions of financial markets, and the impact of fintech peer-to-peer (P2P) services facilitate financial transactions between two people through the use of digital money. Cross-border mobile money has The financial sector fulfills a range of functions that help households, busi- led to a notable decline in average remittance costs across countries41 (see nesses and Governments carry out economic activities. These functions chapter III.B). can broadly be divided into three categories: (i) payments; (ii) intermediation (i.e., savings and borrowing) and (iii) risk management and Distributed ledger technology (DLT) could facilitate messaging, clearing advisory services. and settlement functions (the back end of financial transactions that support cross-border funds transfers). The SWIFT payment system (see chapter Digital technologies are transforming all three areas (table II.1). Their rapid III.F) is currently exploring the use of DLT to improve the speed, trans- spread has accelerated financial innovation and driven the emergence of parency, and end-to-end tracking of payments in its “global payments new actors and solutions. innovation” initiative. DLT have the potential to greatly reduce the cost of trade finance (see chapter III.D) and strengthen correspondent banking (i) Payments relationships. They can be used for regulatory compliance (e.g., compliance Functioning national payment systems and the ability to send and receive with anti-money laundering and combating the financing of terrorism payments across borders are the backbone of the financial system. Over (AML/CFT) standards) through “reg tech”. However, DLT can also be used as the past ten years, mobile money has become an integral part of the a way to avoid compliance (see chapter III.F). payments system in a growing number of countries, extending financial DLT are also impacting money as a medium of exchange. Crypto-assets services to underserved populations. Ten years after M-Pesa (mobile pay- could bring some benefits to financial systems, but they also carry signifi- ment) was first launched in Kenya in 2007, over two thirds of the combined cant consumer and macroeconomic risks that need to be understood and adult population of Kenya, Rwanda, Uganda and the United Republic of managed by regulators. Furthermore, there is evidence that crypto-assets 39 Tanzania are active mobile money users. Anecdotal evidence in two have proven fertile ground for illicit financial activities, including violations sub-Saharan African countries shows that 80 per cent of MSMEs have a of AML/CFT regulations (see chapter III.F for systemic impacts). mobile money account, 83 per cent of which use it for business needs.40 Governments have also made productive use of payments innovations, including to pay government salaries and other associated payments (see (ii) Intermediation (saving and borrowing) discussion on public finance below). Mobile money services have lowered banking fees and increased access to services. This has contributed to a rapid increase in account ownership (see New digital innovations, in combination with existing technologies, are chapter III.B and III.G for fintech trends), even if, to date, there is not yet increasingly widening the functionality of mobile devices for financial strong evidence of an increase in savings rates. transactions. Micro merchants rely on small card readers to accept digital payments; near-field communication technology transforms mobile New technologies also help overcome information failures and information devices into payment services that enable contactless payments; and asymmetries that inhibit lending. For example, lenders that do not know

Table II.1 Traditional financial solutions, fintech solutions, and their underlying technological innovations (i) Payments Cash/ATM Virtual currencies Checks -Wire transfers Mobile payments Debit and credit cards DLT-based settlement / P2P payments Centralized settlement (ii) Intermediation: saving and borrowing Bank deposits and loans Improve efficiency, scope and security in the Blockchain bonds, digital assets, mobile Traditional brokerage delivery of financial services market funds Bonds and equities Brokerage platforms Mortgages Platform lending Crowdfunding (iii) Information management & advisory Structured products Automated wealth management, services Brokerage underwriting robo-advising Regulatory compliance Smart contracts, Regtech Insurance e, KYC -Financial planning and advice Technological innovations Artificial intelligence, machine learning platforms, cloud computing, big data analysis Distributed Ledger Technologies, cryptography, blockchain mobile technology, Internet of Things application programme interfaces Financial institutions depository institutions: banks, credit unions, mortgage loan companies investment institutions: investment banks, underwriters, brokerage firms contractual institutions: insurance companies and pension funds Source: UN DESA, adaptation of IMF.a a IMF, “Fintech: The Experience So Far”, IMF Policy Papers (Washington, D.C., IMF, June 2019).

24 FINANCING SUSTAINABLE DEVELOPMENT IN AN ERA OF TRANSFORMATIVE DIGITAL TECHNOLOGIES the credit quality of borrowers ask for collateral, charge extremely high interest rates, or do not lend at all. This is one of the reasons for the large Report 2020). MSME financing gap. New sources of non-traditional data can provide Removing intermediaries can lower costs and increase market effi- more precise information on creditors, enable financial institutions to ciencies. As financial markets have grown more complicated, the role improve credit screening processes and ultimately increase the supply of of intermediaries has grown more complex. Some financial transac- credit. By evaluating data sets from payments and platforms (such as util- tions involve very long chains of intermediaries89 (sometimes up ity bills, e-commerce transactions or social media profiles), algorithms can to 10 intermediaries), each of whom gets a fee for a small piece of improve credit risk evaluations and provide more precise default predic- market information that is necessary for the transaction. tions. For example, a recent study found that using simple online accessible Yet, completely bypassing intermediaries can also pose risks. One information or “digital footprints” of individuals can exceed the informa- of the primary roles of financial markets is to “intermediate credit” tion content of credit bureau scores, helping lenders make better lending and pool risk. For example, a commercial bank collects customer decisions and even decreasing the need for costly security mechanisms like (demand) deposits and transforms these into long-term loans. collateral.42 In China, Alibaba uses its data, including payment data from The bank is fulfilling a crucial role in pricing and managing credit Alipay, to support the activities of its finance affiliate, Ant Financial. and maturity risk by collecting financially relevant information, However, employing digital technologies in lending decisions can also diversifying risk, and holding adequate reserves. In comparison, create new micro and macro risks. First, there is increasing evidence some crowdfunding platforms act as an agent on behalf of investors that algorithmic lending decisions based on historical data often codify by providing monitoring and servicing functions, but they do not inequalities and biases, thereby perpetuating existing inequalities.43,44 assume systemically important responsibilities like pooling and In addition, in some fintech markets, annualized interest rates (including transforming financial risk. Instead, this risk may remain with small hidden fees) can be very high, sometimes over 100 per cent. There has also investors, who are least able to bear it cost-effectively. been a proliferation of digital lending platforms. In Kenya, there were least Source: UN DESA 49 active digital lending platforms in 2018, and more than a third of mobile phone owners had taken out a digital loan, many of whom (35 per cent) borrowed from more than one digital lender, underscoring the importance (iii) Information management, financial planning and insurance of information-sharing across platforms. Trade-offs between increased efficiencies and heightened risks and equity Instead of supporting productive investment, digital finance may in some concerns also occur in risk management. Algorithmic trading—that is, cases be fueling credit bubbles, with consumer lending dominating credit automated trading instructions that facilitate large and frequent trading growth in some frontier markets.45 In other words, traditional financial transactions—has been around since the 1970s. Thanks to big data, AI and market problems often remain, even in non-traditional financial markets machine learning, algorithmic trading tools have now expanded into in- (see chapter III.F. for a discussion on the role of macroprudential policy to vestment and portfolio management services, and have become accessible address such risks). Digital technologies can help lenders better under- to customers. For example, e-trading platforms and robo-funds employ stand the idiosyncratic risks of companies, but more information does portfolio management algorithms that undertake investments guided by not necessarily solve the fundamental uncertainty inherent in economic the analysis of big data. decision-making or eliminate systemic risks, such as economic slowdowns Rather than reduce market herding, increased reliance on algorithms or shocks (see also box II.6 on P2P platform lending and crowdfunding). could conceivably increase market volatility, which requires further study. Institutional weaknesses that impede markets (e.g., weak legal frame- Digitalization of financial markets has dramatically increased the speed of works) still need to be addressed. This underscores the important role of transactions, as already reflected in “flash crashes”. Widescale implementa- regulators and policymakers in digital transformation. tion of algorithmic trading strategies based on the same big data sources and AI programs could lead to large-scale immediate portfolio reallocations, “correlated mistakes” and greater volatility.46 The growth of crypto-assets Box II.6 and stable coins could pose an additional risk factor (see chapter III.F). Peer-to-peer platform lending and crowdfunding The ability to more precisely assess financial risk enables insurance New technologies have the potential to bypass traditional, weak companies to offer mobile, on-demand, pay-per-usage and parametric credit market infrastructure. Fintech solutions include peer-to-peer insurance solutions. Insights from big data can help customers to reduce (P2P) platform lending and crowdfunding. These mechanisms allow risk premiums or avoid insuring against risk altogether by facilitating individuals to lend directly to borrowers, rather than going through risk prevention. However, the increasing reliance on non-traditional data intermediaries in the traditional financial sector. An interesting sources for screening or monitoring potential risks can also lead to highly feature of this type of lending is that it allows savers more owner- targeted and individualistic pricing models. If taken to their extreme, they ship of their investment decisions (see the upcoming report of the could eventually exclude high-risk groups from insurance markets and Secretary-General’s Digital Finance Task Force); it could also facilitate undermine the foundational principles of risk pooling (see chapter III.B). more sustainable investing, since surveys show individual savers have greater interest in sustainability than their investment advisors Financial market structure: from competition to concentration (see also chapter III.B in Financing for Sustainable Development Digital technologies reduce barriers to market entry and facilitate the decentralization of key functions of financial markets. For example, 25 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

pay-as-you-go access to storage, networking, servers, and other computing nondiscrimination policies, rules and laws to apply to digital practices, or resources in the cloud minimize the cost of operational routines. Application requesting operators of algorithms to assess and disclose bias impacts.51 programme interfaces simplify sharing personal and product data securely They could also consider strengthening programmes that offer conces- among financial institutions. DLT allows simultaneous access, validation, sional lending to groups experiencing discrimination (e.g., women- or and record updating across a network of multiple entities or locations. These minority-owned businesses in the United States). In order to prevent the innovations have facilitated outsourcing of operational and client-facing establishment of disparate regulations across regions and prevent regula- activities. They have also enabled the emergence of new types of financial tory arbitrage, cross-border cooperation is essential. players, such as online P2P or crowdfunding platforms, that can potentially Competition: As discussed, big tech companies’ ability to collect, analyse disintermediate markets and threaten established financial institutions. As and use vast amounts of data could allow them to become dominant a result, incumbents increasingly face revenue loss to fintech innovators. In players in financial markets. While their market entry can promote a recent survey, 88 per cent of incumbent financial institutions worry about innovation, it also challenges the traditional understanding and scope of losing part of their business to fintech companies, and 82 per cent expect to financial regulation. Areas such as competition and data privacy become 47 significantly increase fintech partnerships to improve services. core concerns for financial regulators (see basic building blocks section Perhaps the most significant source of disruption in the financial sector above). Regulators can also aim to level the playing field between big tech is the entry of big tech companies. Because of their size and the vast and traditional financial institutions. To this end, regulatory gaps that may amount of information they possess, they may in the future come to remain between big tech companies and regulated financial institutions— dominate, rather than diversify, the provision of certain financial services around know-your-customer and CFT measures, for example—need to (see chapter III.G). In the longer term, this level of market concentration be closed. could lead to reduced innovation and increased financial fragility. The Financial stability and integrity: Regulatory frameworks may also need failure of these firms could lead to widespread disruption. In China, two to be adjusted to address potential financial stability risks from fintech. To firms account for 94 per cent of the market. Because of their global effectively manage such risks, financial regulators will need to increasingly dominance, big tech companies could also crowd out domestic actors in shift focus to the underlying risks associated with the financial activity smaller markets. rather than the type of financial institution providing financial services. International regulatory standards will also need to adapt to the new What policies are needed to respond to new and emerging landscape. technologies in financial markets? At the same time, policymakers should not discourage innovation or Because technology can change the very structure of financial markets, it nudge financial activities to an unregulated space. Finding this balance is calls into question whether existing regulatory and policy frameworks are challenging, particularly in a fast-evolving space. Institutional experi- adequate to deal with the challenges. In order to maximize benefits and mentation—such as using regulatory sandboxes and modified licensing respond to challenges posed by fintech, regulators and policymakers need agreements—can create controlled environments where new technolo- to revisit and update regulatory frameworks. Most importantly, enhanced gies and innovations can be tested. Sandboxes can encourage greater and new forms of cooperation between different bodies of public oversight collaboration across policy areas and institutions (e.g., between financial will be needed to address the cross-sectoral and cross-border implications regulators, competition authorities and data protection authorities). Dia- of digital technologies. logue with all stakeholders, including new service providers, can facilitate For example, financial regulators and ICT need to cooperate to exploit a better understanding of different perspectives and needs. Spaces for opportunities and risks related to fintech. Given big tech’s business models, peer learning between countries can be helpful, along with enhanced which are built around network effects, and a natural tendency to domi- capacity-building efforts.52 nate markets via economies of scale and scope, regulators will also need to In addition, authorities need to keep a close eye on global systemic explore new ways of cooperation with competition authorities to ensure risks arising from the operation of global crypto-assets and stable coins. a level playing field. Disruptions that cross jurisdictional borders require Digital technologies can also facilitate activities that undermine market international cooperation to prevent regulatory arbitrage. integrity—for example, market manipulation—or for criminal abuse— This section explores national policy actions and international cooperation including money laundering, tax evasion, and purchase of illegal goods or in three areas: (i) consumer protection, (ii) competition (including data) services. Relevant authorities will need to establish comprehensive and and (iii) financial stability.48 advanced RegTech and SupTech capabilities to make AMF/CFT implementation increasingly effective (see chapters III.A and III.F). Consumer protection: Digital technologies give financial institutions access to unprecedented amounts of information on consumers. This requires safeguarding mechanisms to protect consumer data privacy and 3.3 Public finance security (see section on basic building blocks above).49 Where financial Digital technology is reshaping how Governments design and implement institutions outsource operational activities to cloud service providers, their tax, spending and fiscal policies. It has direct impacts on public finan- regulatory frameworks need to ensure the adequacy of information secu- cial management, opening the door for major efficiency and effectiveness rity and data confidentiality.50 To avoid new forms of financial exclusion, gains. But there are indirect impacts as well. A more digitalized economy regulators should work to ensure an ethical and responsible use of AI and creates challenges for public finance and raises new questions about how mitigate for potential biases and discrimination by, for example, updating to mobilize revenue and adapt and prioritize expenditure.

26 FINANCING SUSTAINABLE DEVELOPMENT IN AN ERA OF TRANSFORMATIVE DIGITAL TECHNOLOGIES

Digital technology and public financial management Digital technologies and innovative software also provide an opportunity for tax administrations to improve their efficiency, functioning and Digital technologies can support authorities in managing public resources. enforcement capacities. Technology is creating new tools to improve tax As discussed below, they can compliance and reduce the administrative burden on taxpayers. Technol- Facilitate access to timely and precise information on the state of ogy can help improve the accuracy of information in tax administration the economy; databases, not least with the adoption of e-filing procedures. Big data Facilitate public financial management and service delivery; and analysis can help spot fraudulent tax returns by matching data from different governmental and non-governmental sources. Artificial intel- Improve transparency and accountability. ligence programmes can be created to spot suspicious transactions or tax To do so, the basic building blocks discussed above need to be in place situations, flagging these for review by tax, customs or money laundering across the public sector: appropriate ICT infrastructure, adequate organi- authorities. More targeted enforcement both helps increase domestic zational capacity and skilled staff. Not all technologies are equally suitable revenue mobilization, and also improves the perception of fairness of the for use in all countries, and existing IT infrastructure and institutional fiscal system, and thus strengthens the social contract (see also chap- capabilities may limit the speed at which Governments can transform ter III.B.) their public financial management systems through digitization. Indeed, Transparency and accountability: New digital technologies can also pro- country experiences with previous IT-based reform efforts, such as mote accountability by helping Governments to publish more timely and Financial Management Information Systems, offer cautionary lessons, accurate information on public financial management. They can support and suggest that customized solutions, institutional capacity-building, better engagement with citizens and businesses through fiscal transpar- and clearly identified government needs are prerequisites for successful ency portals, integrated tax portals, e-government services portals, social implementation.53 Where capacities are limited, the focus may need to be media, mobile applications, Short Message Service (SMS), and digital on small pilot programmes, while putting in place conditions that enable publishing of budget proposals. Mobile applications can give individuals a the implementation of some of the basic components of an integrated and convenient and low-barrier way to voice concerns, provide feedback and unified public financial management system.54 effectively monitor and evaluate different aspects of public financial man- Access to timely information: New and emerging digital technologies agement. Moreover, there is a clear link between the levels of integrity and provide Governments with greater data storage capacities and advanced trust in society. Integrity is recognized as a precondition for effectiveness analytical capabilities to analyse the economy. They can increase respon- and for building and maintaining public trust in government, international siveness of government decision-making and service delivery. For example, organizations and civil society. This has been recognized repeatedly and nowcasting can give authorities a timely impression of macroeconomic consistently, most prominently in article 8 of the United Nations Conven- conditions and can support alignment between policy objectives and fund- tion against Corruption (UNCAC). ing. By providing information about current consumption and economic activity through real-time data from value-added and payroll taxes, Public finance in a digitalizing economy nowcasting can help predict output. This is especially useful in countries where daily fiscal data are available but reliable national accounts statistics As digital technologies increasingly reshape economies, their impacts are difficult to obtain.55 on public finance broaden. Digital technologies increasingly affect how countries can raise resources, particularly taxation: as business models Effective and efficient public financial management and service delivery change, companies achieve large scale without mass and service markets Digital technologies can help Governments target public spending and de- where they have no physical presence, raising novel and difficult questions liver programmes and services in effective and cost-efficient ways. This can around taxing rights between jurisdictions. They also affect how countries strengthen the effectiveness of public administration, build public trust can prioritize expenditures. Digital technologies can provide options, for and support the provision of faster, more reliable services to citizens and example, in the design of social protection systems when employment is the private sector, thus removing barriers to the development of the econ- becoming more precarious. omy. Digital payroll and human resources systems can greatly improve the accuracy of payments and increase the convenience of accessing funds. The Taxation in the digital economy: The digitalization of the economy is digitalization of payments to citizens can help reduce leakage and corrup- exacerbating concerns about a century old system of international taxation tion, as well as allocation inefficiencies. Digital government payments have that was already straining to accommodate the globalization of business also been a major driver in enhancing financial inclusion. Account owner- and finance of the previous 30 years. There is a mismatch between where ship has risen sharply in countries that have introduced digital government profits are currently taxed, and where and how value is created. Many transfers. Globally, about 80 million people opened an account to receive jurisdictions are unable to tax some companies that are actively and public sector wages, 120 million to receive a public sector pension, and profitably participating in their domestic markets through digital business 140 million for other public transfers.56 India’s Jan Dhan Yojana scheme models. This is of particular concern for developing countries, because they more than doubled account ownership at financial institutions between have lower tax administration capacity, less bargaining power against digi- 2011 and 2017, reaching 80 per cent of the Indian population and allowing tal platforms, and a lower likelihood of physically hosting digital platforms. direct transfers of government assistance.57 E-procurement systems can Member States are exploring different options for reforming tax norms, increase transparency, increase competition between bidders, and lead to with processes ongoing at the OECD (Organization for Economic Coopera- higher quality public purchases and lower costs.58 tion and Development)/G20 (Group of Twenty) Inclusive Framework for

27 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

BEPS (Base Erosion and Profit Shifting) and at the United Nations Commit- transformation, by building domestic linkages and gradually upgrading to tee of Experts on International Cooperation in Tax Matters. Member States more technology-intensive tasks.63 Entry in these manufacturing value and the Committee of Experts hope to reach consensus on solutions by the chains thus provided an “escalator” to economic progress. This is because end of 2020 and mid-2021, respectively. As the tax landscape evolves in the manufacturing combines three properties: coming years, it is essential to ensure wide and more inclusive participa- (i) Its products are tradeable, allowing developing countries to sell 59 tion of developing countries in international discussions on tax norms beyond small domestic markets; (see chapter III.B). (ii) It combines low-skilled labour with advanced machinery and capital, Social protection for workers on digital platforms: Despite significant facilitating rapid productivity growth;64 progress made in the past, large gaps in coverage and financing in social protection still exist today. Only 45 per cent of the global population (iii) It employs labour with limited skills for the modern economy, which are effectively covered by at least one social protection cash benefit.60 developing countries have in abundance. Digitalization is facilitating good governance in the administration of social Digitalization is changing the calculus in each of these dimensions. protection systems. But it also creates new challenges for coverage and Digital technologies can help make more products and services tradeable, adequacy gaps. This is particularly the case for workers in precarious forms and thus open new opportunities for developing countries to access global of employment mediated by digital platforms in developing countries. markets. As discussed previously, ICT increasingly allow financial, com- While such diverse forms of employment may provide greater flexibility to munication and business services to be traded. New online matchmaking enterprises and workers and lower the cost of services for clients, for work- platforms are expanding possibilities for individuals and small and large ers, they also often translate into lower and volatile earnings and higher companies to hire remote workers to provide services such as communica- levels of income insecurity, inadequate or unregulated working conditions, tion, design and architecture.65 For many MSMEs, digital technologies and no or limited social security entitlements. It is difficult to identify the and the Internet have reduced exporting costs and made it easier to party responsible for contributing to social insurance since neither buyers reach foreign customers through online sales and e-commerce (see also (requesting the service) nor the organizers (digital platforms) may recog- chapter III.D). nize an employment relationship entailing responsibilities with regard to Nonetheless, while they can facilitate entry into global value chains, new social protection. Such gaps in social insurance coverage can also create a digital technologies may make it harder to upgrade within value chains higher burden on the current and future expenditure of social assistance and achieve sustained productivity growth. One trend in global value and poverty alleviation programmes. chains is increasing modularization, which simplifies complex production Several policy options can address these gaps:61 processes by concentrating knowledge-intensive segments into a few Legislative frameworks should be adapted to cover workers on digital stages, standardizing others, and codifying transactions (see also chapter 66 platforms. Workers are almost invariably classified as independent III.D). This has decreased opportunities to upgrade. Advanced digital contractors in the gig economy, and thus fall outside of the legal production technologies remain extremely concentrated in a few countries requirements attached to the standard employment relationship. If (box II.7). misclassified crowdworkers were reclassified as employees, platforms Evidence for the labour-displacing effect of digital technologies is would be obliged to pay minimum wage and ensure social protec- limited so far. Robot-intensity remains very low in the sectors that have tion coverage; typically served as entry points for developing countries, such as textiles, 67 To cover all workers and create a level playing field for employers, apparel and footwear. Reshoring—the relocation of labour-intensive minimum thresholds on enterprise size, working time or earnings for manufacturing activities close to major consumer markets—remains a contributions should be lowered or removed; limited phenomenon. But there are warning signs. Many heavily traded manufacturing sectors are increasingly automated, including electronics, Administrative and financing requirements and procedures can be sim- computers, machinery and equipment. The bar for entry and for retaining plified. Uber drivers in Uruguay, for example, can download a phone competitiveness will be rising more generally: as more tasks can be application that automatically deducts social security contributions. automated, labour will account for a smaller share of production costs; demands on the quality of infrastructure, logistics and connectivity, as 3.4 Development pathways well as educational and skills requirements, will rise.68 Services sectors In response to the increasing digitalization of the global economy, poli- that create low-skill jobs so far remain mostly not tradeable, while those cymakers in developing countries have to adjust their investment, trade, that are tradeable—such as business services or finance—are unlikely to 69 technology, data and competition policies to enable further sustainable absorb large numbers of unskilled labour. development. How should policymakers respond? Since the 1970s, global production processes in the manufacturing sector are increasingly shaped by global value chains, which open opportunities What are promising development pathways in this rapidly evolving con- for developing countries to participate in the global economy, attract text? What policy measures can countries take to pursue them successfully? direct investment, and access global markets and more advanced The answers will depend on a country’s factor endowments and capabili- technologies.62 A number of developing countries were able to lever ties, and its development priorities and needs. But while specific measures these opportunities to achieve rapid and sustained growth and structural will differ, all countries need to be ready to address changes brought about

28 FINANCING SUSTAINABLE DEVELOPMENT IN AN ERA OF TRANSFORMATIVE DIGITAL TECHNOLOGIES

Box II.7 Adoption of advanced digital production technologies: a concentrated global landscapea Digital production technologies (artificial intelligence, big data analytics, cloud computing, Internet of Things (IoT), advanced robotics and other digital technologies applied in manufacturing activities) remain extremely concentrated across countries, sectors and firms. While some emerging economies are entering into the ongoing race, large parts of the world remain marginalized from the productive dynamics of the new digital era. Moreover, even within economies actively engaging with new technologies, the share of firms using them remains very limited. This finding is consistent with the experience of previous technological revolutions, which have divided the world into leading and following economies, depending on countries’ involvement in creating and using emerging technologies. Based on patent and trade data on four core digital production technologies—industrial robots, CAD-CAM, additive manufacturing and machine learning—four broad categories of economies emerge: (i) Frontrunners: This group includes the top 10 economies in terms of innovation and use. They account for 91 per cent of all global patent applications and almost 70 per cent of exports of all capital goods associated with those technologies, and include China, Japan, Germany, the United States of America and several others; (ii) Followers: A second group of 40 economies is actively engaging with new technologies, but to a much lower extent than frontrunners. They include countries active in the production and export of digital production technologies—including advanced emerging economies such as Brazil or India—and those specialized in its use (mainly importers), composed largely of emerging economies such as Mexico, Thailand and Turkey; (iii) Latecomers: Included here are 29 economies with low patent or trade activity involving Advanced Digital Production Technologies (ADP). While they have marginally engaged with new technologies, it is not clear whether they will succeed in becoming followers; (iv) Laggards: These are economies with no or very low engagement with ADP technologies. a This box is based on UNIDO, “Industrial Development Report 2020: Industrializing in the digital age” (Vienna, UNIDO, 2019). Available at https://www. unido.org/resources-publications-flagship-publications-industrial-development-report-series/idr2020. by digital technologies70—whether these are already impacting their country).71 Low-tech labour-intensive production can and likely will coex- economies’ competitiveness, whether these impacts are imminent, or ist with more automated and AI-enabled production. whether they are still some years off. At the same time, investments in the digital economy pay off. Recent Areas for policy action include research covering 12 African countries indicates that Internet access Revisiting development strategies and identifying pathways that facilitated by submarine cables has stimulated job growth in skill-intensive 72 create decent jobs in a digital economy; occupations. This suggests that low-tech production in some sectors can be combined with a parallel focus on enhancing readiness for a more Creating an enabling environment for the digital economy, through digital future.73 skills, regulatory measures, data and competition policies; Promoting innovation and learning in the digital economy; and Creating an enabling environment for digitalization Aligning international engagement with national policy objectives. Section 3.1 discusses the basic building blocks for participating in the digital economy: investing in infrastructure, providing improved access to the Making national development strategies fit for the digital age Internet, enhancing digital skills, regulatory and data policies. Within this Countries’ industrial and sustainable development strategies must ac- context, additional supportive measures can strengthen investment and count for the myriad ways in which digital technologies can affect their trade capabilities. Skills training for employees need to be complemented development prospects. Leading economies (box II.7) will likely focus on by efforts to strengthen managerial and organizational practices and maintaining industrial leadership and on supporting innovation in digital capabilities of firms. “Maker spaces,” technology parks and business in- technologies. The main challenge for technology followers is ensuring cubators can provide continued advice and mentoring for digital start-ups access to technologies and enhancing absorptive capacities. and can complement broader efforts of entrepreneurial knowledge creation through vocational training, internships and apprenticeships.74 Most developing countries will need a two-pronged approach. Pursuing structural transformation in an age of digitalization must be mindful of the Digital business models, characterized by intangible assets that are difficult changing infrastructure, skills and policy requirements. Yet, the adoption to resell and value, pose challenges for traditional financing models. 75 of labour-displacing technologies would not be adviseable in countries Intangibles-intensive industries tend to rely more on equity finance, and where the creation of decent jobs is a major challenge. Opportunities can limited access to finance is one of the main bottlenecks for the development still be exploited in sectors that have not yet been subject to significant of the digital entrepreneurship ecosystems in developing countries. Other technological change. How long this remains possible depends on relative types of financing mechanisms, such as angel investors and venture capital, wage costs, but existing estimates suggest that for a sector such as furni- often play a role (see chapter III.B.). Governments can offer programmes ture, investing in robots would not be economical for another decade (in and instruments for financing innovative activities in the early stages. an African middle-income country) or two (in an African least developed Development banks could also play a useful role in this funding ecosystem. 29 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Competition policies need to adjust for a digital age. Traditional enforcement tools are not well adapted to the business realities of online reviews mergers affecting the COMESA region. The Intergovern- platforms. Non-monetary prices for consumers, personalized pricing mental Group of Experts on Competition Law and Policy of the facilitated by algorithms and other features make it difficult to define United Nations Conference on Trade and Development provides the relevant market, establish a theory of harm, or determine the type an international forum to exchange knowledge and experiences of abuse of market power under current legal frameworks. Competition in the area of competition law and policy.b authorities need to look at markets through a wider lens. Emerging a “Regulation (EU) 2019/1150 of the European Parliament and of the Council issues include addressing competitive relationships and strategies across of 20 June 2019 on promoting fairness and transparency for business users markets; entry barriers; conflicts of interest; the emergence of gatekeep- of online intermediation services”, Official Journal of the European Union (2019). Available at https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?u ers and bottlenecks; and the use and control of data and the dynamics ri=CELEX:32019R1150&from=EN. of bargaining power. For example, merger control regimes should be b See the latest discussions on the competition policy in the digital reformed to be able to scrutinize the acquisition of small start-ups by big economy at UNCTAD, “Competition issues in the digital economy” (United technology companies. Competition authorities need to analyse impacts Nations publication, TD/B/C.I/CLP/54, 1 May 2019); UNCTAD, “Report of the on innovation, potential or future competition, control over data and Intergovernmental Group of Experts on Competition Law and Policy on 76 its eighteenth session” (United Nations publication, TD/B/C.I/CLP/55, 19 entrenching of market power by incumbents (see box II.8 for country August 2019). Available at https://unctad.org/en/Pages/MeetingDetails. examples). aspx?meetingid=1895.

Box II.8 Promoting innovation and learning in the digital economy Competition policies for a digital age The public sector can also play a more proactive role by taking a variety of Countries have taken different steps to create competition policy demand-side measures to support innovation. Because technology has a tools adapted to the new business realities: large tacit component (i.e., knowledge that is not codifiable), it is acquired The revised competition law in Germany includes new criteria in large part through learning by doing. Without public support, the risks to assess the market position of platforms, such as direct and and costs associated with learning and adopting new technologies can indirect network effects; the parallel use of services from dif- outweigh the benefits of competing with established firms from leading ferent providers and the switching costs for users; economies economies. Demand-side measures include the following: of scale arising in connection with network effects; access to Strategic public procurement can be used to support the growth of data relevant for competition; and innovation-driven competi- national digital production capabilities. For example, the e-Sri Lanka tive pressure; initiative included provisions to support the participation of domestic The Government of India’s new e-commerce rules prohibit firms in public IT tenders. Local content promotion was combined with e-commerce platforms from selling products from companies capacity support and awareness raising and has increased local MSME in which they have an equity interest. Platforms are required to participation in winning bids;77 provide services, including fulfilment, logistics, warehousing, Publicly funded research often plays a catalytic role in supporting advertisement and marketing, and payments and financing innovation. Building minimum levels of technological and production to sellers on the platform at arm’s length and in a fair and capabilities typically requires independent research and development non-discriminatory manner. Platforms are not permitted to efforts to build a solid technological base. It also requires access to the mandate any seller to sell any product exclusively in their global knowledge base. The public research system can contribute marketplaces; to strengthening firms’ capabilities to absorb, use, and eventually Regulation can also be used to ensure market access and level develop digital technologies. For example, public funding for research playing fields in digital markets, which may reduce the need for encourages project proposals for advanced digital production tech- ex-post intervention by competition authorities. The European nologies in Colombia and Turkey.78 Governments can also encourage Union (EU) Payment Services Directive (PSD2) allows users to partnerships between existing academic organizations and firms, by transfer data to other service providers. The EU also adopted creating spaces for co-creation and applied research, or set up targeted a regulation to improve fairness of online platforms’ trading research institutions that act as incubators for new businesses;79 practices in June 2019;a “Mission-oriented” interventions can provide incentives or dedicated Competition law enforcement and regulation for big global funding for desirable technologies and outcomes.80 Many countries technology companies are particularly challenging for develop- have initiatives to support specific digital production technology de- ing countries, which often have relatively young competition velopment. Gender-responsive approaches can bring gender analysis authorities with limited resources. In addition, platforms do not into algorithmic and AI design. In the context of digital technolo- necessarily have physical presence in countries where they oper- gies, Governments can also try to steer research and innovation into ate, but their practices affect local businesses and consumers. directions that augment existing workers’ skills and capabilities, rather Regional competition rules and authorities may be an option, than labour-saving technologies that replace labour and contribute to such as COMESA Competition Commission in Africa, which inequality or wage polarization (box II.9).81

30 FINANCING SUSTAINABLE DEVELOPMENT IN AN ERA OF TRANSFORMATIVE DIGITAL TECHNOLOGIES

monopolization. Therefore, multilateral rules to regulate e-commerce Box II.9 may be needed to ensure a level playing field; A robot tax against dystopia? The cross-border and global dominance of global Internet platforms Historically, automation did not lead to mass unemployment thanks can pose challenges for local firms. In some countries, policymakers to the emergence of new sectors and tasks satisfying new demand. have engaged actively with global platforms to ensure that local But what if this time is different? What if robots and artificial intelli- companies have access to them. Others have taken steps to enable the gence outperform humans, replacing more workers than are needed growth of local platforms. For example, prohibiting market access to for emerging tasks? global ride-sharing companies, gave local providers space to develop their own businesses in Ethiopia;83 Robots and computer-assisted machines are not liable to payroll taxes. Yet, formal employer-employee relationships provide the In the digital sector, access to technology can, in principle, be more financial bedrock for social insurance systems that also cover straightforward, given that its products exist as pure applied and unemployment benefits. Rapid automation could thus provide a codified knowledge84. Open-source software makes its source code double shock to public finances, decreasing revenues and increasing publicly available, supporting the development of absorptive capaci- expenditures triggered by mass job displacements. ties. On the other hand, many companies treat their source code as trade secrets. Some recent trade and investment agreements prohibit This would require novel forms of general taxation. Some have Governments from adopting any policies that require sharing of source proposed a “robot tax” to raise revenues to supplement decreas- code, except for national security reasons.85 This includes technology ing labour taxes, and to disincentivize or slow use of job-displacing transfer clauses, joint ventures and training agreements; robots. Lawmakers could, for example, levy a fee on labour-replacing robots equivalent to the payroll taxes paid by employees and Because emerging digital technologies rely on access to large amounts employers, or disallow tax deductions for businesses that invest in of digital data, the regulation of the flow and transfer of data human-replacing technologies. This would correct current biases in across borders takes on increasing importance. Digital data flows the tax code, which often subsidizes capital investment, incentiv- easily across national borders, enabling tighter economic links, value izing automation where human beings would otherwise remain chains and social connections. However, such data flows also create competitive.a At the same time, increasing the cost of innovative challenges for data privacy and security, economic policy and national activities, through additional taxes, could dampen productivity and security. In response, some countries restrict data flows, through data economic growth. localization requirements, tariffs, or bans on trading data. For example, Source: UN DESA Rwanda has adopted a Data Revolution Policy that ensures that it a Daron Acemoglu and Pascual Restrepo, “Automation and New Tasks: retains exclusive sovereign rights on its national data, notwithstanding How Technology Displaces and Reinstates Labor”, Journal of Economic the possibility to host sovereign data outside the country under agreed Perspectives, vol. 33, Issue 2 (2019). terms.86 Several recent and ongoing trade negotiations have sought to ensure free flow of data across borders by imposing constraints on Aligning international engagement with national policy objectives national regulatory interventions. More careful analysis on the costs and benefits of free versus regulated cross border data flows is needed Digital technologies have created new opportunities to access global to understand how technology followers can maintain sufficient space markets. At the same time, increasing global market concentration in some for national regulatory interventions in the interest of legitimate public core sectors of the digital economy threatens to prevent development policies, and effectively build domestic capacities to participate in the of local digital capabilities, platforms and firms. Countries should run a data-driven digital economy;87 coherence check on the “rules of engagement” with the global economy As intangible assets become more important, so does the importance to assess whether they are fit for purpose for this digital age. There is also of intellectual property rights regimes that aim to balance the rights significant scope to further enhance the contributions of development co- and interests of the creators of knowledge with those of its users operation, and South-South cooperation in particular, to help close digital and the larger public interest. Striking this balance is becoming more divides (box II.10). Areas of interest include: difficult in the digital age, particularly because of the nature of new E-commerce is growing quickly, but many of the poorest developing technologies and data as a resource; ease of cross-border transactions; countries struggle to take advantage of opportunities created. The and because of market concentration and market power of lead firms WTO Information Technology Agreement eliminates tariffs on a in core ICT sectors. There is an ongoing debate whether (and if so, how) number of IT products, and WTO members do not currently impose intellectual property systems need to adapt to answer new ques- any custom duties on electronic transmissions (see chapter III.D).82 At tions—for instance, whether data can qualify for intellectual property the same time, the effect these measures may have on tax revenues protection, or to what extent intellectual property protections could is not fully understood, particularly as the digital economy grows in constrain national authorities in regulating AI and other algorithms size, and in light of challenges with digital taxation. They may also put with regard to their social impacts. These questions require further local firms at a disadvantage in those areas (such as online platforms) study and discussion.88 that are characterized by strong cross-border concentration and

31 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Box II.10 Development cooperation in a digital world The adoption and utilization of digital technologies remains highly uneven across the globe. Development cooperation can help close these gaps, and international dialogue can enhance peer learning across countries in a rapidly evolving field. Most major development cooperation providers have adopted digital strategies to promote the use of digital technologies in development projects, and to support digitalization for sustainable development in partner countries. Yet, while development cooperation actors recognize the importance of digitalization, available estimates suggest that only a small fraction of official development assistance is dedicated to it (see also chapter III.G).a For example, only 1 per cent of project funding by multilateral development banks targeted the information and communications technology sector between 2012 and 2016.b South-South digital cooperation and regional integration initiatives can play an important role in sharing good practices and learning from existing regulatory experiences. Areas of significant promise includec Broadband ecosystem: More advanced developing countries can support others in developing broadband infrastructure to create a level playing field and access to opportunities arising from digital services; Digital payment infrastructures and e-commerce: Regional digital payment infrastructure capacities such as the Integrated Regional Electronic Settlement System of the Southern Africa Development Community facilitate financial transactions at the regional level and support regional e-commerce. Flanked by a regional e-commerce strategy that provides uniform rules for consumer protection, intellectual property, competition, taxation and information security, this can foster the integration of regional markets; Development banks and digital entrepreneurship: National and regional development banks can play an important role in financially supporting micro, small and medium-sized enterprises to develop digital innovations and technology for use at the regional level. Intraregional investments in digital technologies can foster technology transfers between regions if they allow source-code sharing. Source: UN DESA a UNCTAD, “Donor support to the Digital Economy in Developing Countries”, UNCTAD Technical Notes on ICT for Development No. 13 (United Nations publication, TN/ UNCTAD/ICT4D/13, March 2019). b World Wide Web Foundation, “Closing the investment gap: How Mulitilateral Development Banks Can Contribute to Digital Inclusion” (Washington, D.C., World Wide Web Foundation, April 2018). Available at http://a4ai.org/wp-content/uploads/2018/04/MDB-Investments-in-the-ICT-Sector.pdf. c UNCTAD, “South-South Digital Cooperation for Industrialization: A Regional Integration Agenda” (United Nations publication, UNCTAD/GDS/ECIDC/2018/1, 2018).

Endnotes 1 Chen Long and Michael Spence, “Mapping the Digital Economy in 2020” (6 December 2019). Available at https://www.project-syndicate.org/onpoint/ digital-economy-analysis-management-by-chen-long-and-michael-spence-2019-11. 2 The World in 2050 initiative, TWI2050 Report: The Digital Revolution and Sustainable Development: Opportunities and Challenges (Laxenburg, International Institute for Applied Systems Analysis, 2019). 3 ITU, “Digital Technologies for Achieving the 2030 Agenda” (forthcoming). 4 For an overview of current studies and estimated job losses, see Thereza Balliester and Adam Elsheikhi, “The Future of Work: A Literature Review”, ILO Research Department Working Paper No. 29 (Geneva, International Labour Office, 2018); Andrew Keisner and others, “Breakthrough technologies – Robotics, innovation and intellectual property”, WIPO Economic Research Working Paper No. 30, (Geneva, WIPO, 2015). 5 David Autor and David Dorn, “The Growth of Low-Skill Service Jobs and the Polarization of the US Labor Market”, American Economic Review, vol. 103, Issue 5 (August 2013), pp. 1553-1597. 6 Dani Rodrik, “New Technologies, Global Value Chains, and the Developing Economies”, Pathways for Prosperity Commission Background Paper Series No.1 (Oxford, Pathways for Prosperity Commission, 2018). 7 Dani Rodrik, “Premature deindustrialization”, Journal of Economic Growth, vol. 21, Issue 1 (2016). 8 Raul Katz and Fernando Callorda, The economic contribution of broadband, digitalization and ICT regulation (Geneva, ITU, 2018). Available at https://www. itu.int/pub/D-PREF-EF.BDR-2018. 9 See for example, for a ‘techno-pessimist’ view, Robert J. Gordon, The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War (Princ- eton, Princeton University Press, 2015).

32 FINANCING SUSTAINABLE DEVELOPMENT IN AN ERA OF TRANSFORMATIVE DIGITAL TECHNOLOGIES

10 Erik Brynjolfsson, Daniel Rock and Chad Syverson, “Artificial Intelligence and the Modern Productivity Paradox: A Clash of Expectations and Statistics”, The Economics of Artificial Intelligence: An Agenda (Chicago and London, The University of Chicago Press, 2019). Available at https://faculty.chicagobooth.edu/ chad.syverson/research/aiparadox.pdf. 11 ITU, Measuring digital development: Facts and figures 2019 (Geneva, ITU, 2019). Available at https://www.itu.int/en/ITU-D/Statistics/Documents/facts/ FactsFigures2019.pdf. 12 Robert Bartlett and others, “Consumer-Lending Discrimination in the FinTech Era”, NBER Working Paper No. 25943 (Cambridge, National Bureau of Economic Research, June 2019). 13 Mark West, Rebecca Kraut and Han E, “I’d blush if I could: closing gender divides in digital skills through education” (EQUALS Skills Coalition and UNESCO, 2019). 14 Digital Economy Report 2019: Value Creation and Capture: Implications for Developing Countries (United Nations publication, Sales No. E.19.II.D.17). 15 The World in 2050 initiative, TWI2050 Report: The Digital Revolution and Sustainable Development: Opportunities and Challenges. 16 Pathways for Prosperity Commission, “Charting Pathways for Inclusive Growth: From Paralysis to Preparation” (Oxford, Pathways for Prosperity Commis- sion, 2018). Available at https://pathwayscommission.bsg.ox.ac.uk/charting-pathways-report. 17 Avi Goldfarb and Catherine Tucker, “Digital Economics”, Journal of Economic Literature, vol. 57, Issue 1 (March 2019), pp. 3-43. Available at https://doi. org/10.1257/jel.20171452. 18 See for example Carl Benedikt Frey and Michael Osborne, “The Future of Employment: How Susceptible are Jobs to Computerisation?”, Oxford Martin School Working Paper (Oxford, University of Oxford, 17 September 2013). Available at https://www.oxfordmartin.ox.ac.uk/downloads/academic/ future-of-employment.pdf. 19 See for example Digital Economy Report 2019. 20 See for example Ana Paula Cusolito, Raed Safadi and Daria Taglioni, Inclusive Global Value Chains: Policy Options for Small and Medium Enter- prises and Low-Income Countries (Washington, D.C., World Bank and OECD, 22 August 2016). Available at https://openknowledge.worldbank.org/ handle/10986/24910. 21 Digital Economy Report 2019. 22 Ibid. 23 See for example David Autor and others, “The Fall of the Labor Share and the Rise of Superstar Firms”, Quarterly Journal of Economics (forthcoming). 24 Digital Economy Report 2019. 25 World Development Report 2016: Digital Dividends (Washington, D.C., World Bank, 2016). 26 ICT Infrastructure business planning toolkit 2019 (Geneva, ITU, 2019). Available at https://www.itu.int/dms_pub/itu-d/opb/pref/D-PREF-EF. ICT_STRUCT_KIT-2019-PDF-E.pdf. 27 Global Value Chain Development Report 2019: Technological Innovation, Supply Chain Trade, and Workers in a Globalized World (Geneva, WTO, 2019). 28 ICTs, LDCs and the SDGs: Achieving universal and affordable Internet in the least developed countries (Geneva, ITU, 2019). Available at https://www.itu.int/ dms_pub/itu-d/opb/ldc/D-LDC-ICTLDC-2018-PDF-E.pdf. 29 Ibid. 30 Maya Escueta and others, “Education technology: an evidence-based review”, NBER Working Paper No. 23744 (Cambridge, National Bureau of Economic Research, August 2017). 31 The State of the World’s Children 2017: Children in a Digital World (New York, UNICEF, 2017) 32 SME Competitiveness Outlook 2018: Business Ecosystems for the Digital Age (Geneva, ITC, 2018). 33 World Development Report 2016: Digital Dividends. 34 Digital Economy Report 2019. 35 Ibid. 36 See for example Digital Economy Report 2019; OECD, “Data in the digital age” (Paris, OECD, March 2019). 37 White and others, Digital identification: A key to inclusive growth (McKinsey Global Institute, April 2019). 38 Sushil Bikhchandani and Sunil Sharma, “Herd behavior in financial markets”, IMF Working Paper WP/00/48 (Washington, D.C., IMF, 2000). 39 GSMA, “2017 State of the Industry Report on Mobile Money” (London, GSMA, 2018). Available at https://www.gsma.com/mobilefordevelopment/ resources/2017-state-industry-report-mobile-money/. 40 Nika Naghavi, “Sub-Saharan Africa: The enduring epicentre of mobile money – Part 2”. Available at https://www.gsma.com/mobilefordevelopment/ africa/sub-saharan-africa-the-enduring-epicentre-of-mobile-money-part-2/.

33 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

41 World Bank, “Remittance Prices Worldwide”, (Washington, D.C., World Bank, 2019). 42 Tobias Berg and others, “On the rise of fintechs–credit scoring using digital footprints”, NBER Working Paper No. 24551 (Cambridge, Massachusetts, National Bureau of Economic Research, April 2018). 43 For example, comparing the default predictions that a hypothetical lender would make by using a traditional statistical model to predictions derived from an algorithm that bases lending decisions on supervised machine learning techniques, data from US mortgage lending suggests that the gains from fintech based lending tend to favor racial groups that already face an advantage in traditional credit markets. 44 Andreas Fuster and others, “Predictably Unequal? The Effects of Machine Learning on Credit Markets” (6 November 2018). 45 For example, in 2017 one Sub-saharan African country reported a growth of 2000 SME loans vs. 2 million consumer loans, see https://www.boz.zm/ credit-market-monitoring-reports.htm. 46 Joseph Stiglitz and others, Stability with Growth: Macroeconomics, Liberalization and Development (Oxford, Oxford University Press, 2006). 47 Manoj Kashyap and others, “Global FinTech Report 2017” (London, PwC, 2017). Available at https://www.pwc.com/gx/en/industries/financial-services/ assets/pwc-global-fintech-report-2017.pdf. 48 Kathryn Petralia and others, Banking disrupted? Financial Intermediation in an Era of Transformational Technology, Geneva Reports on the World Economy 22 (Geneva, ICMB Studies, 2019). 49 Ibid. 50 Johannes Ehrentraud and others, Policy responses to fintech: a cross-country overview, FSI Insights on policy implementation, No. 23 (BIS, January 2020). 51 Nicol Turner Lee, Paul Resnick and Genie Barton, “Algorithmic bias detection and mitigation: Best practices and policies to reduce consumer harms”, Brookings Report (Washington, D.C., Brookings Institution, 22 May 2019). 52 Chales Taylor, Aquiles Almansi and Aurora Ferrari, “Prudential Regulatory and Supervisory Practices for Fintech: Payments, Credit and Deposits” (Wash- ington, D.C., World Bank, 2020). 53 Marco Cangiano, Alan Gelb and Ruth Goodwin-Groen, “Public Financial Management and the Digitalization of Payments”, CGD Policy Paper 144 (Wash- ington, D.C., CGD, June 2019). 54 AlphaBeta, “Digital Innovation in Public Financial Management (PFM): Opportunities and implications for low-income countries” (AlphaBeta, July 2018). 55 Sanjeev Gupta and others (eds.), Digital Revolutions in Public Finance (Washington, D.C., IMF, 2017). 56 Asli Demirgüç-Kunt and others, The Global Findex Database 2017: Measuring Financial Inclusion and the Fintech Revolution (Washington, D.C., World Bank, 2018). 57 Reserve Bank of India, “Trend and Progress of Banking in India 2017 - 2018” (Mumbai, Reserve Bank of India, 2018), p.79. Available at https://www.rbi. org.in/scripts/AnnualPublications.aspx?head=Trend%20and%20Progress%20of%20Banking%20in%20India. 58 OECD, “Productivity in Public Procurement: A Case Study of Finland: Measuring the Efficiency and Effectiveness of Public Procurement”, (Paris, OECD, 2019). Available at https://www.oecd.org/gov/public-procurement/publications/productivity-public-procurement.pdf. 59 See for example Digital Economy Report 2019. 60 World Social Protection Report: Universal social protection to achieve the Sustainable Development Goals (Geneva, ILO, 2017). 61 Policy options presented below draw heavily on the Report for the Recurrent Discussion on Social Protection. Christina Behrendt and Quynh Anh Nguyen, Innovative approaches for ensuring universal social protection for the future of work, ILO future of work research paper series (Geneva, ILO, 2018). 62 See for example Richard Baldwin, The Great Convergence: Information Technology and the New Globalization (Cambridge, Harvard University Press, 2016). 63 Trade and Development Report 2018: Power, Platforms and The Free Trade Delusion (United Nations publication, Sales No. E.18.II.D.7). 64 Dani Rodrik, “Premature deindustrialization”. 65 Richard Baldwin, The Globotics Upheaval: Globalization, Robotics, and the Future of Work (Oxford, Oxford University Press, 2019). 66 Global value chain development report 2019: Technological Innovation, Supply Chain Trade, and Workers in a Globalized World (Geneva, WTO, 2019). 67 Ibid. 68 Mary Hallward-Driemeier and Gaurav Nayyar, Trouble in the Making? The Future of Manufacturing-Led Development (Washington, D.C., World Bank, 2018). 69 Dani Rodrik, “New Technologies, Global Value Chains, and the Developing Economies”. 70 See, for instance, UNCTAD Rapid eTrade Readiness Assessment. Available at: https://unctad.org/en/Pages/Publications/E-Trade- Readiness-Assessment.aspx. 71 Karishma Banga and Dirk Willem te Velde, “Digitalization and the future of manufacturing in Africa” (London, ODI, March 2018). 72 Jonas Hjort and Jonas Poulsen, “The Arrival of Fast Internet and Employment in Africa”, American Economic Review, vol. 109, Issue 3 (March 2019), pp. 1032-79.

34 FINANCING SUSTAINABLE DEVELOPMENT IN AN ERA OF TRANSFORMATIVE DIGITAL TECHNOLOGIES

73 Karishma Banga and Dirk Willem te Velde, “Digitalization and the future of manufacturing in Africa”. Available at https://www.odi.org/publication s/11073-digitalisation-and-future-manufacturing-africa. 74 Digital Economy Report 2019. 75 Jonathan Haskel and Stian Westlake, Capitalism without capital: the rise of the intangible economy (Princeton, Princeton University Press, 2018). 76 UNCTAD, “Report of the Intergovernmental Group of Experts on Competition Law and Policy on its eighteenth session” (United Nations publication, UNCTAD/TD/B/C.I/CLP/55, 2019). Available at https://unctad.org/meetings/en/SessionalDocuments/ciclpd55_en.pdf. 77 Fernando Santiago and Miriam Weiss, “Demand-driven policy interventions to foster sustainable and inclusive industrial development in developing countries”, Inclusive and Sustainable Industrial Development Working Paper Series WP 17 (Vienna, UNIDO, 2018). Available at https://www.unido.org/ api/opentext/documents/download/10378548/unido-file-10378548. 78 UNIDO, “Industrial Development Report 2020: Industrializing in the digital age” (Vienna, UNIDO, 2019). 79 OECD, “Innovation policies in the digital age”, OECD STI Policy Papers No. 59 (Paris, OECD, November 2018). 80 Mariana Mazzucato, The Entrepreneurial State (London, Anthem Press, 2014). 81 Anton Korinek, “Labor in the Age of Automation and Artificial Intelligence”, Econfip Research Brief (January 2019). Available at https://econfip.org/ wp-content/uploads/2019/02/6.Labor-in-the-Age-of-Automation-and-Artificial-Intelligence.pdf. 82 Global value chain development report 2019: Technological Innovation, Supply Chain Trade, and Workers in a Globalized World (Geneva, WTO, 2019). 83 Digital Economy Report 2019. 84 see Financing for Sustainable Development Report 2019 (United Nations publication, Sales No. E.19.I.7) 85 Trade and Development Report 2018: Power, Platforms and the Free Trade Delusion (United Nations publication, Sales No. E.18.II.D.7). 86 Ibid. 87 Digital Economy Report 2019. 88 Ibid. 89 Vincent Glode, Christian C. Opp, Xingtan Zhang, “On the efficiency of long intermediation chains”, Journal of Financial Intermediation, vol.38 (2019), pp. 11-18.

35 Infographic Goes Here DOMESTIC PUBLIC RESOURCES Chapter III.A

Domestic public resources 1. Key messages and recommendations

Domestic public resources have a unique role to play in sufficient resilience and flexibility so they can face unexpected financing for sustainable development. The link between circumstances, such as the rapid spread of COVID-19 in the first revenue collection and effective expenditures for quality quarter of 2020. In such situations, revenues are likely to decline public goods and services forms the basis of the social contract as economic activity slows, while expenditures may increase, between citizens and the state. Member States of the United especially health-sector spending. Nations also recognized that significant additional domestic Governments should invest in technology to support all parts public resources are necessary to realize sustainable develop- of the fiscal system, such as tax administration, enforcement ment and committed to enhancing revenue mobilization. of laws against financial crimes, and budget execution. Such Since 2015, there have been improvements in tax policies and investment should be aligned with medium-term revenue international cooperation in some significant areas, yet five and expenditure plans, and can be supported by interna- years into the implementation of the agenda, positive reforms tional partners. There is enormous scope to use technology have not been fully integrated and aligned across sectors to strengthen public financial management and reap returns and institutions—nationally or internationally. The slow in greater revenue mobilization and more efficient spend- and steady progress in domestic public resource mobilization ing. This includes relatively old technologies, such as digital is insufficient to match the scale and ambition of the 2030 databases for expenditure and tax administration, as well as Agenda for Sustainable Development. Only about 40 per cent new technologies, such as artificial intelligence and distrib- of developing countries clearly increased tax-to-gross domestic uted ledgers. product (GDP) ratios between 2015 and 2018. Political will for The continued digitalization of the economy is also making tax reform and assistance for capacity-building are inadequate, norms agreed almost a century ago obsolete. Any new interna- while sustainable development is not yet universally prioritized tional tax norms being developed to address challenges from in expenditure allocation and budget processes. technology must be well-tailored for developing countries— Many more Members States should be preparing multi-year including the least developed and smaller countries—and country plans for tax policy and administration reform, to inclusive of developing-country voices in their formation increase revenue mobilization and support public investment and agreement. Countries need to be afforded sufficient to achieve sustainable development. For medium-term rev- additional time to determine the advisability of reforms enue strategies to be effective, they should be country-owned, before they are agreed and provided with technical assistance reflect development priorities, be prepared by the whole of to accurately assess the medium- and long-term impact of government, and have the full backing of national political proposed changes on their economies. leaders. This reinforces the social contract and accountability While significant progress has been made in international tax to citizens, who can demand better service delivery alongside cooperation, the interests and voice of developing economies more effective governance. require greater priority and attention. The global community Fiscal reform plans should also take account of existing could better ensure effective inclusion in tax norm-setting capacities and impediments and should focus on the binding processes; adaptation of tax norms and practices to the constraints to greater revenue raising, which can help countries realities and needs of developing countries; and greater prioritize actions to raise revenues. Fiscal systems also need investment in capacity-building from development partners. 37 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Countries without access to information, and without sufficient domestic capacity to enforce increasingly complex international tax norms, will be 2. Domestic resource mobilization unable to boost revenue mobilization related to cross-border activity. Policy actions on illicit financial flows (IFFs) lag behind the political 2.1 Taxation trends and medium-term revenue strategies rhetoric. To be most effective, efforts for tackling IFFs should focus on In 2018, available data shows that 53 developing countries increased tax specific components. International cooperation is needed to tackle revenues,1 while 46 countries registered a decline. Middle-income coun- all aspects of IFFs. Especially important actions include spontane- tries and small island developing States (SIDS) saw increases in tax revenue ous information-sharing and mutual legal assistance. Internationally, (measured as the median tax revenue-to-GDP ratio) to 19.2 per cent and tax-related IFFs are being tackled with some of the international tax 21.6 per cent, respectively, while least developed countries (LDCs) saw a cooperation tools. Effective national actions for combatting tax-related, slight decrease to 12.1 per cent (figure III.A.1).2 The median tax revenue-to- corruption and other kinds of IFFs in all countries include: more capac- GDP ratio of developed countries decreased slightly, largely due to personal ity to prevent and investigate suspicious transactions; more effective and corporate tax reform in the United States of America that prompted cross-institutional coordination in national enforcement; and more as- a drop in tax revenue from 26.8 per cent of GDP in 2017 to 24.3 per cent in siduous implementation of national commitments made under the United 2018.3 Tax revenues have reached a plateau in most developed countries, Nations Convention Against Corruption. ending the trend of annual increases seen since the 2008 financial crisis. New technologies, such as crypto-assets, are facilitating IFFs, underscoring the importance of concerted enforcement efforts and constant vigilance Figure III.A.1 Median tax revenue by country group, 2000–2018 of the financial system. New technology, such as artificial intelligence, (Percentage of GDP) can enable better identification of suspicious activity—for example, by 30 matching tax filing data to other data sets, such as customs declarations, financial account information, or real estate transaction registers. 25 However, technology should be only one component of a broader political 20 strategy to tackle illicit finance. 15 Nationally and internationally, corruption occurs as public and non-state 10 actors respond to the incentives and social and economic constructs 5 that are present. Embedding new expectations and social norms, along 0 with shifting political settlements related to accountability, transpar- 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 ency and integrity will require leadership from the top as well as Least developed countries Middle-income countries localized, sector- and context-specific actions. Countries also need to Small island developing States Developed countries step up implementation of prior commitments and cooperation on stolen asset recovery and return. More regular and rigorous statistical Source: IMF. information-sharing on legal assistance requested and provided, as well as the results in terms of assets returned, can be useful. Tax revenues vary widely by region. Many regions saw little annual change in median tax revenue as a percent of GDP in 2018. Between 2012 and 2017, How revenues are spent is as important as the amount mobilized. tax revenues fell in Asia and Africa, regions with the lowest median tax Medium-term expenditure frameworks, which complement revenue revenue figures as a percent of GDP (figure III.A.2). This is in contrast to frameworks, bring together a holistic picture of the fiscal system. Europe, Oceania, and the Americas, which saw a recovery of tax revenues Expenditure frameworks should be aligned to the SDGs which can be over this period, following a fall in revenues after the 2008 financial crisis. facilitated by being part of integrated national financing frameworks (INFFs). Some countries have already started mapping their budgets to Figure III.A.2 the Sustainable Development Goals (SDGs). Policymakers should embed Median tax revenue by region, 2002–2017 gender equality and women’s economic empowerment in expendi- (Percentage of GDP) ture and strategic procurement across all sectors. Spending should 30

be informed by national disaster risk reduction financing strategies. 25 Similarly, environmental sustainability needs to be made a core element of domestic public investment policies if we are to meet climate goals. 20 Multilateral agencies provide tools for these and other areas, including 15 capacity-building. 10 This chapter begins by reviewing trends in taxation, tax administration and tax avoidance and evasion. It then provides an update on international 5 tax cooperation, including an analysis of proposed changes to tax norms 0 related to the digitalization of the economy. The next section provides Asia Africa Europe Oceania Americas an examination of IFFs, before the final section explores ways to align 2002 2007 2012 2017 expenditure and procurement with sustainable development. Source: IMF.

38 DOMESTIC PUBLIC RESOURCES

Revenues also vary widely from country to country within a single region. Developing countries are more reliant on corporate income taxes than While revenues in Africa fell on average across the region from 2012 to developed countries, a reliance that in middle-income countries has grown 2017, this mainly reflects the impact of the fall in commodity prices on tax over the last two decades. Developing countries, particularly SIDS, also rely revenues in commodity-dependent countries; tax revenues rose in 21 more on trade taxes, although recent increases in tariffs (see chapter III.D) non-commodity dependent countries over the period. The Arab region is may temporarily affect the tax mix in some large economies. illustrative in this regard. Total revenues (which includes taxes, royalties and other revenues) in oil-producing countries fell over this period, while Figure III.A.5 those of oil importers increased (figures III.A.3 and III.A.4). In the wake of Median tax revenue by type of tax, 2017 (Percentage of GDP) the commodity price falls, many countries in the Arab region expanded tax revenue to offset royalty declines, but this failed to compensate. Oil 30 exporters have introduced fiscal consolidation measures, although oil 25 importers have as well. In this region, additional revenue could be 20 mobilized through tax reforms that improve progressivity and compliance and broaden the tax base.4 15

Figure III.A.3 10 Median tax revenue, Arab region, 2000–2018 5 (Percentage of GDP) 18 0 16 Total tax Corporate Personal Total goods Trade tax 14 revenue income income and revenue 12 tax revenue tax revenue services tax revenue 10 Least developed countries Middle-income countries 8 6 Small island developing States Developed countries 4 Source: IMF. 2 0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Figure III.A.6 All Arab region Oil exporters Oil importers Median goods and services tax revenue, 2002–2017 (Percentage of GDP) Source: IMF. 14 12

10 Figure III.A.4 Median total revenue, Arab region, 2000–2018 8 (Percentage of GDP) 6 60 4 50 2

40 0 Developed Least developed Small island Middle-income 30 countries countries developing States countries 2002 2007 2012 2017 20 Source: IMF. 10

0 Tax policies and decisions on the optimal tax mix for each country will 2000 2002 2004 2006 2008 2010 2012 2014 2016 20182018 depend on national economic and social structures, as well as national All Arab region Oil exporters Oil importers political priorities. But they are also influenced by and must respond to global trends, such as the impact of technological changes on wages and Source: IMF. profit shares (see chapters I and II). In a global environment of low interest Revenue by tax type shows additional structural differences in tax rates, countries with access to markets may find borrowing more politically revenues between countries and regions. All countries rely on taxes on expedient than undertaking onerous tax reforms. The political environ- goods and services followed by income taxes, with low (and often falling) ment for changes in the tax mix also needs to be considered, as widening shares of corporate taxation. Most of the increase in taxes since 2007 came the tax base means some constituencies that previously were not paying from taxes on goods and services (primarily value added tax (VAT)), with (or were paying very little) income tax will now be asked to make greater the strongest increases in LDCs and SIDS (figures III.A.5 and III.A.6). contributions to domestic public resources.

39 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Figure III.A.7 Median tax revenue by type of tax, by region, 2017 (Percentage of GDP) 20

0 Total tax revenue Corporate income tax Personal income tax Total goods and Trade tax revenue revenue revenue services tax revenue Africa Asia Americas

Source: IMF. Medium-term revenue strategies increased between 2016 and 2017, suggesting either decreasing capacity of tax administration or an increase in productivity of staff, perhaps The 2019 Financing for Sustainable Development Report highlighted the through adoption of technology. The percentage of female staff and execu- importance of integrated government planning in raising resources and tives in tax administration increases with higher country-income levels achieving the SDGs. A medium-term revenue strategy (MTRS) can be a cor- (figure III.A.9). More equitable representation of women among staff at nerstone of effective tax reform and development policy and an important tax administrations and in finance ministries, which often make tax policy, element of broader effective government planning. (Such broader planning can assist in ensuring that the gender impacts of fiscal policies are more can happen through INFFs.) An MTRS is a comprehensive approach to tax effectively included in decision-making. reform, based on revenue goals that are aligned with development needs, including social and economic equality, gender parity and inclusion, and There are also other tools available that can help countries as they prepare environmental impacts. It considers revenue mobilization to support great- revenue strategies. For example, the Tax Administration Diagnostic As- er public investment as well as the revenue system’s impacts on economic sessment Tool (TADAT) is an assessment framework used to measure key and social development. By linking revenue collection to expenditure for components of a tax administration.6 As at end-January 2020, 92 TADAT quality public service delivery through political and business cycles, an assessments have been conducted. The framework is being used (both MTRS can strengthen the social contract between citizen and state. formally and informally) to guide high-level decisions on tax administration reform efforts. Additionally, some customs administrations are using Developing a country-owned MTRS can be a mechanism for Governments relevant elements of the TADAT framework—such as risk management, to meaningfully address their own unique challenges in revenue mobiliza- voluntary compliance and revenue accounting—to monitor performance tion, as well as a framework within which Governments can adapt and and implement remedial measures. adjust reforms as implementation challenges arise. As of 2019, 19 countries are in some stage of development of an MTRS in collaboration with the In- Adoption of technological tools can increase capacity and productivity of ternational Monetary Fund (IMF) or the World Bank Group.5 Twelve other tax administration staff and compliance with a tax regime. There are key countries have begun the process of dialogue pre-formulation, including differences in the use of technology in tax administration among countries workshops, consultations with stakeholders, and initial tax policy analysis. of different income levels. For example, effective adoption of electronic filing not only streamlines efforts for the tax administration but can also 2.2 Tax administration reduce compliance costs for taxpayers.7 Use of e-filing is significantly lower in low-income countries than in middle- or high-income countries, Strengthened tax administration is an important component of although rates increased from 2016-2017 across all groups (figure III.A.10). medium-term planning. Tax administration suffers from lower capacity Similarly, lower-middle-income countries have the highest adoption rates in LDCs and some middle-income countries. Low-income countries have on average of electronic payments, which lag in low-income countries approximately one tenth of the staffing of high-income countries (figure (figure III.A.11). This indicates significant scope for improvements in ef- III.A.8). In all income groups, population per tax administration employee ficiency of administration through adoption of digital technologies. 40 DOMESTIC PUBLIC RESOURCES

Figure III.A.8 Figure III.A.9 Median population per full-time tax administration employee, Average percentage of female sta and executives in tax by income group, 2016–2017 administration, by income group, 2016–2017 (Number of population) (Percentage of sta )

14 000 70

60 12 000 50 10 000 40 8 000 30 6 000 20

4 000 10

2 000 0 2016 2017 2016 2017 0 Percentage sta who are female Percentage executives who 2016 2017 are female Low-income countries Lower-middle-income countries Low-income countries Lower-middle-income countries Upper-middle-income countries High-income countries Upper-middle-income countries High-income countries

Source: IMF, International Survey on Revenue Administration. Source: IMF, International Survey on Revenue Administration.

Figure III.A.10 Average percent of returns e- led by type of tax, by income group, 2016–2017 (Percentage of returns) 90

0 2016 2017 2016 2017 2016 2017 Corporate income tax Personal income tax Value added tax Low-income countries Lower-middle-income countries Upper-middle-income countries High-income countries

Source: IMF, International Survey on Revenue Administration.

Traditional technology and software solutions can simplify tax adminis- taxpayers. For example, technology can help strengthen accuracy of infor- tration and provide an enhanced suite of e-services for taxpayers, with mation in tax administration databases. Connected devices, such as secure options ranging from integrated, purpose-built solutions to purchased, electronic cash registers, can measure and transmit accurate real-time best-of-breed components to a comprehensive, commercial, off-the-shelf data and boost tax compliance by addressing unreported sales.9 The tax administration solution.8 International partners are already helping technology at the heart of the sharing and gig economy also creates data, countries with such solutions. Digital technology is also creating new which can be used to facilitate transparency and simplification of tax obli- tools to improve tax compliance and reduce the administrative burden on gations, with minimal burden on taxpayers and administrations alike.10 41 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Figure III.A.11 Average percent of electronic tax payments, by income group, 2016–2017 (Percentage of returns) 60

0 2016 2017 2016 2017 By number By value

Low-income countries Lower-middle-income countries Upper-middle-income countries High-income countries

Source: IMF, International Survey on Revenue Administration.

Big data approaches (see chapter II) can help identify suspicious or incor- likelihood of payment in full by individual taxpayers. If the taxpayer rect information. Combined with artificial intelligence (AI), it can also be believes the tax system to be fair, that others with similar income are also used to improve identification of tax evaders. Some country authorities paying their taxes, and that the quality of public services matches the tax have experimented with using hack-a-thons—intense technology devel- burden, trust in the tax system may grow and even a taxpayer with the opment sessions involving programmers and public officials—to quickly ability to evade taxes may not believe evasion is justified.11 In practice, develop new AI tools that make use of multiple databases to validate this virtuous circle can take many years to achieve, as changing social information. Such approaches rely on the ability of multiple agencies and norms related to tax payment is difficult. Efforts to enhance tax compliance ministries, as well as potentially subnational authorities, to share informa- through raising trust need to be complemented with effective and credible tion while maintaining trust and privacy. In the most advance practices, enforcement and facilitation measures.12 Governments can use non-government data to help validate governmental Additionally, taxation of multinational entities (MNEs) is more complicated data or flag suspicious information. given their ambiguous participation in national social contracts. There For most developing countries, it is still too early to assess the impact of is some evidence that MNEs pay proportionately less tax than small and advanced technologies (such as AI), determine good practices, and target medium-sized enterprises (SMEs),13 and it is clear that actual taxes paid investments likely to have higher returns. However, the technologies are much lower than statutory tax rates, often by design.14 Multinational do hold promise for countries at all levels of development. Investment enterprises design their tax strategies at headquarters and may not partici- in revenue administration, including in technology adoption, should be pate in the social contract in any particular host country in the same way considered carefully alongside the entire package of revenue reforms, as a domestic enterprise. Internal MNE payment and other systems may with investment that is tied to medium-term plans and coherent with the incentivize staff to design corporate tax strategies that avoid corporate overall financing framework. International partners can back these invest- taxation in the host country.15 ments with financing and capacity-building. There are gray areas between tax avoidance/minimization techniques and 2.3 Tax avoidance and evasion unlawful tax evasion. For example, especially aggressive transfer-pricing approaches can be found, on further scrutiny by tax authorities, to have Revenue losses due to tax avoidance and evasion have direct negative crossed over the blurry line between avoidance and evasion. Cross-country impacts on the ability of the state to provide public and social services and analysis of data from the International Survey on Revenue Administration indirect impacts on inequality and trust in the government and effective- shows that for tax audits—including those of individual and corporate ness of the state. taxpayers and across all types of audits (comprehensive, issue oriented As taxes are a key component of the social contract, the perception of and desk based)—rates of success are above 50 per cent. Figure III.A.12 fairness of the system and the quality of public services can impact the shows that a very high percentage of comprehensive audits find that 42 DOMESTIC PUBLIC RESOURCES taxpayers are underreporting, although the relatively higher success rates in lower-income countries relate to a much lower number of audits. Data 3. International tax cooperation from the United States shows that around 70 per cent of corporate income The Addis Agenda recognizes the need to scale up international tax tax returns undergoing further examination are subject to additional tax cooperation as a complement to national tax policy and administration payments after examination,16 although the majority of audits do not reform. The globalization of financial activities, and the advances in result in prosecutions for tax evasion. There are two implications: some technology that reduce barriers to goods and financial flows, necessitate taxpayers are using aggressive tax strategies that cross the blurry line, but countries working together on tax matters and combatting illicit finance it also indicates the need for greater clarity in the law to reduce the pres- (see section 4). Through cooperation, countries can address the challenges ence of gray areas. of corporate and personal tax avoidance and evasion while encouraging The Task Force has regularly provided references to estimates of inter- investment through fair distribution of taxing rights. national corporate tax avoidance and evasion, predominantly in the form of corporate tax base erosion and profit shifting (table III.A.1). New 3.1 Progress on tax transparency research confirms previous findings that developing countries are more Tax transparency and exchange of information between Governments pro- susceptible to profit shifting by multinational corporations than developed vides tax authorities with access to banking, ownership, accounting and countries.17

Figure III.A.12 Comprehensive audit hit rate, by income group, 2016–2017 (Percentage of audits) 100

0 2016 2017

Low-income countries Lower-middle-income countries Upper-middle-income countries High-income countries

Source: IMF, International Survey on Revenue Administration.

Table III.A.1 Selected international corporate tax avoidance estimates Volume estimate Underlying data used Estimate provider Tax loss of 0.07% of world gross product in 2015 (approx. $50 Meta-analysis of estimates of impact of tax rates on profit Beer, S., Mooij, R. de, & Liu, L. (2019). “International Corporate Tax billion) from profit shifting declaration Avoidance: A Review of the Channels, Magnitudes, and Blind Spots”. Journal of Economic Surveys. Tax loss of $660 billion in 2012, or almost 1% of world gross Survey of US multinational groups carried out by the Bureau Cobham, Alex, & Janský, P. (2019). “Measuring misalignment: The domestic product of Economic Analysis location of US multinationals’ economic activity versus the location of their profits”. Development Policy Review, 37(1), 91–110. Tax loss of $194 billion in 2016 Differential reporting of foreign direct investment shares Janský, P., & Palanský, M. (2019) “Estimating the scale of profit based on reported rates of return shifting and tax revenue losses related to foreign direct investment”. Int Tax Public Finance, 26, 1048–1103. Source: Inter-agency Task Force on Financing for Development. Note: Volume estimates are not comparable.

43 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

other types of information necessary for tackling cross-border tax evasion also reciprocally activate a bilateral relationship and satisfy confidential- and avoidance. New and updated legal instruments to promote exchange ity requirements. So far, 95 members of the Global Forum have begun of tax information and mutual assistance among tax authorities have had a exchanging financial account information automatically. Information on significant impact on tax collection. 47 million financial accounts with a total value of around €4.9 trillion were As shown in figure III.A.13, many developing countries do not partici- exchanged through 4,500 bilateral exchange relationships in 2018. The pate in international tax cooperation instruments, with slow growth in number of bilateral relationships grew to over 6,000 in 2019. In aggregate, participation since 2017. LDCs in particular lag significantly behind in their middle-income countries now have over 1,500 relationships for receiv- participation. For non-participating countries, most of which have not had ing information, although no LDCs are receiving data from automatic a role in shaping the underlying tax norms, choosing whether to participate exchanges. A number of developing countries have either elected not to requires an assessment on multiple dimensions, which may include whether receive information or have not yet passed the confidentiality require- the rules are well adapted to their circumstances, whether they have the ments to be able to receive. capacity to implement the rules effectively, and the possible opportunity Using this data (i.e., checking whether the data received matches taxpayer costs of deprioritizing other potential tax policy or administrative reforms. declarations) requires sophisticated tax information systems and human The Global Forum conducts peer reviews of all its member jurisdictions for capacity. Such information systems can make use of AI and machine compliance with international standards for transparency and exchange of learning to identify suspicious activity and accounts that should be more information for tax purposes. This includes both exchange of information rigorously examined (see chapter II). As automatic exchanges com- on request—which includes banking, ownership, financial accounting menced only recently, there is no comprehensive data yet on the amount and other types of information—and automatic exchange of information of tax recovered due to the discovery of misreported information by the on financial accounts of non-residents. A survey of Global Forum members taxpayer. Still, taxpayers may fear audits and thus provide more accurate provides indicative information that exchange of information requests declarations of offshore assets, paying more tax as a result. Participation 19 have been increasing over time.18 in voluntary disclosure programmes and data on deposits in offshore accounts (see section 4.2 below) back this assumption. These changes in To receive information on the financial accounts of non-residents automati- behaviour mean that any calculation of the payoff from investing in a more cally, countries must not only adhere to the relevant conventions, but must technologically sophisticated tax administration may be underestimated.

Figure III.A.13 Participation in international tax cooperation instruments, 2017–2019 (Number of countries, cumulative) 140

120

100

0 SIDS SIDS SIDS SIDS SIDS SIDS SIDS MICs MICs MICs MICs MICs MICs MICs Total Total Total Total Total Total Total –20 LDCs LDCs LDCs LDCs LDCs LDCs LDCs MCAA Common MCAA exchange Mutual Assistance Automatic Global Forum on Multilateral Inclusive Reporting of country-by- Convention – for Exchange of Transparency Instrument (MLI) – Framework on Standard – on country reports– exchange of tax Information and Exchange of to implement BEPS–OECD-housed nancial account related to MNE information Standard – for Information for tax-treaty related body for the information activity on request exchange of Tax Purposes – measures for implementation tax information OECD-housed reducing BEPS of the 2015 between countries body for review of BEPS package simplementation of tax transparency standards

End-2017 End-2018 End-November-2019

Source: OECD. Note: Middle-income countries (MICs). Small island developing States (SIDS). Least developed countries (LDCs). Multilateral Competent Authority Agreement (MCAA).

44 DOMESTIC PUBLIC RESOURCES

One of the most highly sought changes in tax information exchange relates on the arm’s length principle (i.e., using market prices to value internal group to the exchange of country-by-country reports of MNEs. Country-by-coun- transactions). However, arm’s length pricing may not adequately reflect try information can help tax authorities assess the risk that MNEs are not value creation in highly digitalized businesses, when intangible assets are an fairly applying arm’s length transfer pricing (i.e., valuing internal group important part of value creation, or if interactions with users creates value transactions at fair market prices, and thus not shifting profits to low cost for businesses. This has led to questions about the appropriate threshold of jurisdictions). The development of country-by-country reporting for MNEs economic engagement that justifies the right for corporate income taxation was agreed as part of the OECD/G20 BEPS Action Plan in 2015 and will in a jurisdiction and the most appropriate methods of profit allocation. be reviewed this year. Forthcoming changes to tax norms related to MNE The policy discussions on how to address the range of challenges have ad- taxation in the context of increased digitalization (see section 3.2), may vanced significantly since 2019. At the OECD-housed Inclusive Framework warrant changes to the information that is shared, either in these reports on BEPS, a Programme of Work was agreed as the basis for negotiations or through new reporting requirements. in May 2019, which contained two pillars of work: (i) a review of the rules As of end-2019, over three quarters of the members of the Inclusive that determine if a business has a taxable presence (called “nexus” in tax Framework on Base Erosion and Profit Shifting (BEPS) have introduced a agreements) and how profits should be allocated; and (ii) global minimum country-by-country reporting filing requirement. As a result, substantially taxation rules giving jurisdictions the right to “tax back” when taxpayers every MNE with consolidated group revenue above €750 million is now are subject to low levels of effective taxation in other jurisdictions (called preparing country-by-country reports for their home jurisdiction. However, the Global Anti-Base Erosion proposal, or “GloBE” for short). host jurisdictions can only get access to non-local country-by-country For pillar one, the OECD secretariat had issued a proposal for a “unified reports by agreeing to another international instrument and having a bilat- approach”.20 It would create (i) a new definition of which businesses have eral match. At end-November 2019, there were more than 2,000 bilateral a taxable presence that does not rely on physical presence, and; (ii) a profit exchange-of-information relationships for country-by-country reporting; allocation rule that uses formulas, rather than arm’s length pricing, for 933 of these involve middle-income countries, up from 745 in 2018 and apportioning some of their profit. This approach is more complex than the 477 in 2017. Currently no LDCs receive country-by-country reports through original ideas outlined in the 2019 Financing for Sustainable Development information exchange. Report. Rather than redefining what is a taxable presence for all businesses, the unified approach proposes that a new definition only applies to compa- 3.2 Taxation of the digital economy nies that either have highly digital business models or are consumer-facing The 2019 Financing for Sustainable Development Report outlined the businesses. Second, the proposal on profit allocation suggests that, for conceptual issues countries face as they grapple with taxation of the digital these businesses, corporate profit would be split into three different economy (see also chapter II). The growth of e-commerce and digital components with different rules applying to each component (figure business models can disrupt different fiscal systems, including indirect and III.A.14). The proposal does not yet include precise definitions or thresholds direct taxation. for each component. One of those three different components relates to baseline distribution and marketing, for which the proposal is suggesting The increased supply of goods or services across borders has introduced a simplification of existing rules so that there is a fixed amount of profit challenges to collecting VAT and goods and services taxes (GST). The allocated to the source country. This new fixed remuneration could be complexity of organizing, administering and enforcing VAT/GST payment applied to all businesses. under traditional rules when the supplier and the digital platform are not located in the jurisdiction of the customer can cause considerable revenue The complexity of the proposal has generated significant debate and losses if no appropriate measures are taken. A key question is what role disagreement on the wisdom of adopting such rules and their usefulness 21 country authorities expect of digital platforms in the collection of VAT/GST to developing countries. Recently, one systemically important country on online sales and whether the legal framework is in place to enable them proposed that the new pillar one norms be implemented on a safe harbour 22 to play that role. The Organization for Economic Cooperation and Develop- basis, which would allow companies to either opt in or opt out of the ment (OECD) has developed standards to address the complexity, including rules globally. This could, depending on the regime for those that opt out, through VAT/GST-collection obligations for e-commerce marketplaces and put Governments’ tax collection in a weaker place than today. other digital platforms. Over 50 countries, including 12 middle-income A further feature of the proposal is the creation of effective and binding countries, have already implemented these standards, and other develop- dispute prevention and resolution mechanisms to improve tax certainty. ing countries are looking to do so. Rather than trying to collect VAT/GST Currently, given the sovereign nature of tax, countries generally resolve tax from digital platforms, other countries are making collection a require- disputes with taxpayers domestically. However, as the adjustments made ment for other actors in the supply chain, such as financial institutions by a tax authority in one country may lead to double taxation of an MNE, issuing credit cards in their jurisdictions. Such approaches are relatively many countries agree, through their tax treaties, to mutual agreement new, and it is too early to assess their effectiveness. procedures through which the tax authorities of the countries involved In relation to the taxation of multinational corporate profits, digitalization seek to resolve the double taxation. These procedures are not mandatory, changes the demands on residence-based and source-based taxation be- and country authorities generally retain sovereignty to determine what is cause it is now easier to operate in a market without triggering tax residency the appropriate amount of tax due in their jurisdiction. The new proposal rules. In the traditional tax rules, taxation in the source country is usually creates a new approach to allocating profits internationally and, as a result, based on physical presence in the jurisdiction. Once the right to tax the MNE suggests new methods to resolve disputes and prevent double taxation. has been established, MNE profits are allocated between jurisdictions based It seeks to limit the ability of countries to seek tax payments that they 45 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Figure III.A.14

What is the business size (based on revenue)?

Small companies Arm’s length transfer pricing would continue to determine pro t allocation as in existing rules

Large companies To include split of pro ts between • Those from “baseline” What is the business model? marketing and distribution, Not consumer facing and not digital as per Amount B below: Arm’s length transfer pricing would xed return based on arm’s continue to determine pro t length transfer pricing allocation as in existing rules (uniform percentage) • Pro ts above baseline, as per Relatively small consumer-facing or Amount C below: allocated digital business lines based on arm’s length Arm’s length transfer pricing would transfer pricing continue to determine pro t allocation as in existing rules

Consumer facing or digital businesses

these are described as Amount A, Amount B and Amount C. use of formula

jurisdiction: xed return based on arm’s length transfer pricing (uniform percentage)

arm’s length transfer pricing

Source: UN DESA.

determine are due, although the details have not yet been agreed. Manda- The members of the Inclusive Framework agreed to a statement on the tory binding arbitration on tax disputes is opposed by many developing two-pillar approach in January 2020, which affirmed their commitment countries, not least because many countries have negative perceptions of to reach an agreement on a consensus-based solution by the end of binding arbitration brought under investor-statement dispute settlement 2020,23 but also recognized that significant divergences will need to be clauses that are part of many international trade and investment agree- resolved. Many Inclusive Framework members have expressed concern that ments (see chapter III.D). implementing pillar one on a safe harbour basis could raise major difficulties, On pillar two, related to minimum taxation, the proposal aims to enable increase uncertainty and fail to meet all of the policy objectives of the process. countries to subject all corporate profits of MNE groups to a minimum The members aim for final decisions to be taken by consensus and as a pack- level of effective taxation. It includes a number of complementary age, with agreement on key policy features at the next meeting in July 2020. mechanisms: income inclusion at the level of shareholders, application Many countries have questioned the wisdom of agreeing to new rules to foreign branches and subsidiaries, denying deductions for certain without full and accurate economic impact assessments. Assessments are intragroup payments, source-based taxation of other payments, and difficult to prepare because of a lack of accurate country-by-country infor- coordination with other rules. The actual minimum rate of tax to be mation for all MNEs and significant uncertainty over the final thresholds applied under the pillar two proposal has not yet been discussed by the and definitions that would be applied. Preliminary analysis prepared by Inclusive Framework. the OECD, presented in February 2020, estimates the increase in global 46 DOMESTIC PUBLIC RESOURCES tax revenue as a result of the two pillars combined at up to $100 billion 3.3 Capacity-building efforts annually.24 The estimates of revenue gains are concentrated in developed countries with large economies, but, as a percentage of corporate tax The discussion above underscores the importance of strengthening revenues, are broadly similar across jurisdictions at all income levels. capacities for tax policy design, administration and enforcement. Such investment has high returns and should support country-owned and Discussions are also ongoing in the United Nations Committee of Experts on country-created strategies for revenue mobilization. To meet the needs International Cooperation in Tax Matters’ Subcommittee on Tax Challenges of a changing world, tax capacity-building also needs to adapt. Indeed, Related to the Digitalization of the Economy. The United Nations is holding when developing countries agree to new norms in their interests, they a large workshop in September 2020 to build the capacity of developing often need to build new capacities to implement those norms effectively. country officials who will be advising their ministers and participating Yet, there is no single best strategy for provision of capacity-building, nor in the international negotiations on taxation of the digitalized economic a single type of intervention that is more effective across all countries. In activity. This capacity may also help authorities engage in regional tax 2016, the Platform for Collaboration on Tax (box III.A.1) made recom- cooperation mechanisms to coordinate measures, as well as consider mendations on enhancing the effectiveness of external support in alternatives in case no agreement is reached. Norms that are better adapted building tax capacity in developing countries, which remain relevant to to developing-country capacities will necessitate less capacity-building, and capacity-building partners.25 thus may more quickly deliver financial returns in terms of increased revenue. There are now four years of data on the volumes of official development The 2019 Financing for Sustainable Development Report set out several di- assistance (ODA) dedicated to enhancing domestic public resource mobili- mensions of analysis that should be undertaken on proposed new tax norms: zation. In 2018, ODA disbursed for this purpose jumped 23 per cent year on (i) the enforceability of the proposals given tax administration capacities; year to reach $261 million, or 0.22 per cent of ODA, still short of the 2016 (ii) impact on existing tax policies; and (iii) the distributional impact of the peak of $329 million. proposals. These remain recommended dimensions of analysis that Member The PCT partners are increasing their capacity-building. Examples States should undertake. They can guide an understanding of whether new include Tax Inspectors Without Borders, a joint initiative of OECD and proposals will further exacerbate tax gaps described in the first section the United Nations Development Programme; technical assistance of this chapter, lead to increased revenue mobilization, or undermine the related to implementing new or revised tax transparency and exchange long-term ability of Governments to align tax policies with sustainable of information standards; the United Nations trainings of tax officials, development. In the Addis Agenda, Member States emphasized the impor- back-to-back with meetings of the United Nations Tax Committee and tance of inclusive cooperation and dialogue among national authorities on its subcommittees; the approximately 180 person years of technical international tax matters. This emphasis should be retained as countries assistance in the latest fiscal year provided by IMF; and the World Bank’s decide on tax norms that could potentially be in place for another century. new public-private partnerships on the use of innovative technologies for tax administrations. Box III.A.1 Platform for Collaboration on Tax The Platform for Collaboration on Tax (PCT) is a joint effort, launched in 4. Illicit financial flows 2016, by the United Nations, World Bank Group, International Monetary Combating illicit financial flows (IFFs) involves an essential develop- Fund, and Organization for Economic Cooperation and Development ment challenge, as IFFs reduce the availability of valuable resources for (OECD) to intensify cooperation on tax issues across international achievement of the 2030 Agenda. There is no agreed definition on what institutions. The PCT work plan, outlined in its most recent progress constitutes “illicit financial flows” and this term still generates disagree- a report, consists of three main workstreams: (i) detailed exchange of ment. The Task Force agreed in 2017 that there are generally three information on domestic revenue mobilization capacity development components of IFFs (although not mutually exclusive or comprehensive): (i) activities; (ii) analytical activities; and (iii) outreach activities. IFFs originating from transnational criminal activity; (ii) corruption-related The platform partners have developed an online information IFFs; and (iii) tax-related IFFs (figure III.A.15). As the different components platform that consolidates the data from the four organizations that are not comparable, the Task Force has noted that separate analysis of is being launched as part of the revamped PCT website in March channels or components is more effective and can prevent double counting 2020. Additionally, PCT partners have continued to coordinate on in aggregations. work related to medium-term revenue strategies (MTRS) and develop Because IFFs are, by definition, a cross-border phenomenon, action to toolkits for developing countries. PCT partners are also working on combat them needs to be taken at both national and international levels. the revision of the guidelines on the tax treatment of official develop- Policy responses are best considered in a component-by-component or ment assistance by actively participating, along with the OECD channel-by-channel approach, although some measures can be effective Development Assistance Committee, in the relevant subcommittee against multiple types of IFFs. IFFs, regardless of the component, will of the United Nations Tax Committee. PCT partners also offer training typically pass through or involve many people. Proxies, advisors, interme- on the application of PCT toolkits. Plans for 2020 also include the diaries, financial institution staff, and professional service providers (e.g., organization of two regional workshops around MTRS. lawyers, accountants) are all involved in the typical chain of transactions a World Bank, “Platform for Collaboration on Tax: PCT Progress Report 2018- that move a resource to the resulting asset. Companies and firms that 2019 (English)”. control markets, direct financial flows, pay bribes, or set the stage for

47 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

state capture are involved. This emphasizes the importance of the eco- A conceptual framework for IFFs, including a concise definition and typol- system of institutions needed to combat illicit financial flows; it is not just ogy to define the scope of measurement was submitted to the Inter-agency financial intelligence units, tax administrations, and customs agencies. and Expert Group on SDG indicators (IAEG-SDG), which develops the global Standard-setting and regulation, supervision and enforcement are also indicator framework for the SDGs. In October 2019, the IAEG-SDGs endorsed relevant to combatting the enablers of illicit finance. A more synchro- a reclassification of the indicator to Tier II, signifying that it is conceptu- nized whole-of-government approach is needed, including professional ally clear, has an internationally established methodology and standards, service and financial regulators and supervisors, prosecutors, the judiciary, but that data is not yet regularly produced by countries. This framework foreign and finance ministries, and political decision-makers. Internation- defines IFFs “as financial flows that are illicit in origin, transfer or use; that ally, greater focus on improving policy coherence must continue to be reflect an exchange of value instead of purely financial transactions; and a priority, that cross country borders.” Four main categories of IFFs are identified in this conceptual framework, according to the activity generating them: tax 4.1 Volume estimates and commercial practices, illegal markets, theft and terrorism financing, and corruption. In essence, it further refines this Task Force’s schematic ap- In early 2019, the United Nations Conference on Trade and Development proach (figure III.A.15), by dividing IFFs related to criminal activity into two and the United Nations Office on Drugs and Crime (UNODC)—the joint cus- separate categories: (i) illegal markets and (ii) theft and terrorism financing. todians of SDG Indicator 16.4.1 on illicit financial flows—established a Task Force on the Statistical Measurement of Illicit Financial Flows, composed of The next steps include the development of statistical methodologies to representatives of official statistics, tax and customs authorities of several underpin estimations at country level. These estimates will shed light countries in Europe, Africa and Latin America, as well as international insti- on the most appropriate statistical methodologies to estimate IFFs and tutions, including Eurostat, the IMF, OECD and the United Nations Economic provide additional evidence to help policymakers prepare or target 26 Commission for Africa. interventions.

Figure III.A.15 Schematic diagram of illicit nancial ows

Components of IFFs Channels of IFFs Resulting asset

Unrelated group trade transactions (good trade mis-invoicing, services)

wealth holdings (deposits, securities, Transnational Intra-MNE transactions special purpose criminal activity (transfer mis-pricing, goods vehicles) trade mis-invoicing, services)

Real estate Tax-related Businesses

Capital account channels Other moveable (FDI, other investment, loans) Corruption related assets (cars, boats, art, etc)

Other transactions (Cash, remittances, real estate titles)

Source: Inter-agency Task Force on Financing for Development. Note: Resulting asset will be considered a ‘stolen asset’ if it is the product of corruption-related IFFs. Components of IFFs include both source of funds and motivations of IFFs and may not be mutually exclusive. Individual transactions from di erent channels may be combined by actors to try to obscure the source, motivation and/or use of funds. Arrows do not represent estimates of the magnitude of ows, and are illustrative rather than comprehensive.”

48 DOMESTIC PUBLIC RESOURCES

4.2 Policy measures for tax-related IFFs positively correlated with a perceptions-based indicator called “control of corruption,”30 but causal relationships are difficult to establish, in part Tax-related IFFs are being tackled with some of the international tax because of the difficulty in accurately measuring corruption. cooperation tools described earlier, which increase tax transparency and exchange of information and make it more difficult to hide wealth or trans- Different acts of corruption also have vastly different impacts on sustain- actions through offshore structures. The global exchange of information able development and the breaking of the social contract. Grand scale network facilitates access to the information and assistance from the des- theft of public assets and state capture have fiscal implications, and tination (or intermediary) countries for IFFs. A recent study finds that bank possibly broader macroeconomic ones, while also destroying public trust deposits in international financial centres from non-bank counterparties, of the state. Highly localized low-ticket bribery related to service delivery which increased significantly from the early 2000s to 2008, fell by 24 per generally does not impact on the fiscal system nor have a broader macro- cent ($410 billion) by the first quarter of 2019. These falls are significantly economic impact, although it can have significant impacts on the victims correlated with the country hosting the financial centre signing automatic of bribery who may be extremely poor and thus may suffer dispropor- exchange-of-information agreements.27 tionately even from a small bribe. There is evidence in several spheres for corruption being associated with worse environmental outcomes.31 The Global Forum has incorporated into its standards a requirement to ensure the availability of beneficial ownership information for all legal Extractive industries, due to the large volumes of transactions, rents and entities and arrangements. This is resulting in a synergy between the profits connected with mining and fossil fuel exploitation, seem to attract Financial Action Task Force (FATF) (see section 4.4) and the Global Forum more attention from corrupt actors than other sectors. This relationship processes, and enables extensive peer review of countries performance has motivated the early and more advanced development of transparency on beneficial ownership information, covering both legal framework and norms in the sector, such as the Extractive Industry Transparency Initiative enforcement in practice. Since 2016, one third of the recommendations and the European Union’s adoption of an Accounting Directive that has, (164 out of 418) issued to jurisdictions in Global Forum peer reviews have since 2016, required public country-by-country reporting of payments to pertained to beneficial ownership information, indicating that more needs Governments by the extractive and logging industries. On the positive side, to be done to fully implement the beneficial ownership requirements. surveys of firms in many countries suggest a decline in bribery. The techniques used to launder the proceeds of crimes and to commit tax Programmes that have successfully reduced corruption have been associ- crimes are often similar. There is a need to improve cooperation between ated with much higher tax revenue generation.32 National frameworks tax and anti-money-laundering authorities. International institutions for transparency and accountability can reduce the opportunities for have provided tools and training for how tax authorities can assist in corruption, but the success of any particular framework in reducing cor- money-laundering awareness.28 Key lessons are the need for efficient ruption will depend on the national political settlement and institutional information-sharing and a culture and mechanisms of cooperation arrangements.33 Procurement policies (see section 5.2) can be models between the two types of authorities. for public transparency and accountability. Political arrangements can sometimes undermine both the effective enforcement of formal rules 4.3 Tackling corruption and state capture and corruption prevention strategies. In these contexts, anti-corruption interventions can be prioritized based on political feasibility and the Corruption is a complex social, political and economic phenomenon that criticality of the sector to wider anti-corruption efforts. Interventions can affects all countries. Many international organizations have adopted a defi- thus be organized sequentially based on the scale of impact on sustainable nition of corruption that encompasses the abuse of public office for private development prospects.34 gain. The United Nations Convention against Corruption (UNCAC) lists bribery, embezzlement, abuse of functions, trading in influence, obstruction of Technology can be useful in disrupting existing norms or incentives. For justice, and money-laundering as types of corruption. Private corruption, example, using technology to distribute government service access can which involves the misuse of any entrusted position for private gain at empower citizen voice, change the dynamics of service delivery, and the expense of the interest of a company or society, is included. Many bolster the social contract. Long-term success usually requires redistribut- corrupt transactions involve both public officials and private sector actors. ing power and changing norms, for which a new stable political settlement Corruption often involves entrenched power structures, systems of societal must be found. relations, and social norms which together form a system of incentives The UNCAC is the only legally binding universal anti-corruption instru- that bind a network of actors into a governance arrangement that does not ment. The Convention’s far-reaching approach and the mandatory involve impersonal application of neutral rules.29 By undermining trust character of many of its provisions make it a unique tool. The Convention in Governments, corruption not only results in immediate potential loss of covers the four main pillars of anti-corruption: preventive measures; resources but also undermines the social contract. This reinforces political criminalization of corruption and law enforcement; international settlements that involve low public resource mobilization and ineffective cooperation; and asset recovery. Based on peer reviews in the areas of service delivery by Governments. criminalization of corruption and law enforcement and international The impacts of corruption come in political, economic, social, and even cooperation, conducted under the Implementation Review Mechanism of environmental outcomes. Corruption may lead to higher profits for UNCAC, a set of non-binding recommendations and conclusions can help the companies involved, as well as reductions in public revenue and guide Member States.35 Highlights of these good practices include (i) inefficient public expenditure. The impact of corruption on growth has strengthening data collection; (ii) the adoption of comprehensive legisla- been studied extensively. Empirical research finds that GDP per capita is tion for the confiscation of proceeds of crime; (iii) access to information by 49 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

law enforcement authorities; (iv) the cooperation of private sector with AI software that can be applied in many jurisdictions could introduce ef- anti-corruption authorities; and (v) expanding the spontaneous trans- ficiencies of scale, thereby lowering costs for individual countries. Regional mission of information that could assist in investigations and criminal tax and anti-money-laundering cooperation bodies can be venues for proceedings in other countries. exploring joint work. However, they cannot be one-off developments, as the software and tools will need to constantly evolve to spot the latest 4.4 Money-laundering standards loopholes and threats. Combating money-laundering helps to preserve the integrity of In early March 2020, the President of the General Assembly and the financial institutions, both formal and informal, and protect the smooth President of the Economic and Social Council jointly launched a High-level operation of the international financial system. The UNCAC includes Panel on International Financial Accountability, Transparency and Integrity article 14, which obligates all States parties to set up a regulatory (FACTI Panel). The panel will produce an interim report outlining its analy- regime for financial institutions in order to deter and detect all forms sis in July 2020, and its final report providing recommendations in February of money-laundering, while article 23 requires the criminalization of 2021. The General Assembly is organizing a Special Session on corruption the laundering of proceeds of crime. In the Addis Agenda, Member in April 2021. States committed to identify, assess and act on money-laundering risks, including through effective implementation of the FATF standards on anti-money-laundering/counter-terrorism financing. As its 40 members 5. Expenditure and strategic and observers include all members of the Group of 20, and all major financial centres, FATF standards operate as de facto global standards for the procurement in public budgets world’s financial system. FATF conducts peer review for adherence to its As the main vehicle for implementing government policy, the budget standards, as do nine FATF-style regional bodies covering most countries should be intimately linked with the attainment of SDGs. Budget processes of the world. are a critical link in the chain connecting sustainable development objectives, strategies and plans, public spending and, finally, outcomes.36 A 4.5 Asset recovery and return well-formulated medium-term budget framework (MTBF) is a natural platform for integrating the SDGs with domestic public resource allocation. The process of tracing, freezing, confiscating and returning stolen assets These MTBFs need to be coherent and consistent with other elements of a to their country of origin is usually a complex and lengthy one, involving country’s INFF. multiple jurisdictions and often complicated by technical, legal or political barriers. Chapter V of UNCAC provides the framework for the return of Most countries require significant additional spending to achieve the SDGs. stolen assets, requiring States parties to take measures to restrain, seize, By making use of multi-year estimates of expenditure and revenue to confiscate, and return the proceeds of corruption. frame budget decisions, an MTBF enables a strategic approach to budget preparation and spending priorities. This highlights the costs and potential The Stolen Asset Recovery (StAR) Initiative, a joint project of the World trade-offs of various policies. For example, some types of transport policies Bank Group and UNODC, promotes implementation of Chapter V of which provide short-term economic gains ultimately conflict with climate UNCAC. StAR is currently conducting a new survey on international asset objectives. Strong MTBFs are based on an iterative budget process that recovery efforts in corruption cases. The study aims to collect data on aims to reconcile the top-down fiscal discipline set by ministries of finance global progress in international efforts to recover and return proceeds of with bottom-up costing of policies by spending ministries. Effective MTBFs corruption in a systematic and internationally comparable way. Better data need not be overly rigid, as line ministries may need some flexibility to on corruption-related asset recoveries and returns worldwide is needed adapt to developments on the ground, such as a disaster or epidemic. to promote the timely return of proceeds of corruption; identify trends Indeed, the outbreak of COVID-19 in early 2020 demonstrates this need in asset recovery practices and volumes; provide an evidence base for for spending flexibility, as governments facing rapid spread of the disease policymaking; promote transparency and accountability in international needed to use emergency spending to bolster public health systems, asset recovery; and measure progress towards commitments. More specific including for provision of medical care for those who caught the virus and recommendations in the area of asset recovery are also being distilled from for implementation of preventative measures. the second cycle of peer reviews under the UNCAC Implementation Review Mechanism, which is currently in progress. In the shorter-term, financial management information systems (FMIS) support the automation and integration of public financial management processes including budget formulation, budget execution, accounting, 4.6 International responses and reporting. These technological tools have been increasing in efficiency On the global level, international institutions continue to support countries. and effectiveness since they started to be widely adopted in the 1980s. The World Bank will be issuing a Global Corruption Report in mid-2020. FMIS can significantly improve the efficiency and equity of government The IMF executive board plans to do a stock-take on the institution’s work operations and service delivery. If used effectively and strategically, they on IFFs in September 2020, which will showcase the Fund’s wide-ranging also offer potential for increasing participation, transparency and account- work in this area and identify gaps to be addressed. One area for possible ability in expenditure. More advanced FMIS can directly integrate with the further cooperation is in developing the technological tools that can be provision of e-governance, where public services are provided online (see used to help identify and combat IFFs. While such tools will need to be chapter II). adapted to individual country contexts and risk factors, the creation of 50 DOMESTIC PUBLIC RESOURCES

5.1 Financial instruments for expenditure targets and verification metrics. Failed service provision is also possible, as is inequitable treatment of service recipients, especially if the primate Governments have honed their public financial management skills over partner aims to cut costs. It may also have negative impact on work condi- decades. While each government’s procedures and tools might be slightly tions and terms of service for public employees. Finally, some critics point different, countries have standard ways to budget and spend resources. out that investors may profit off the delivery of public services, which may Still, many are looking for new tools, instruments and innovations that can exacerbate inequality and undermine the social contract. These instru- lead to better expenditure which is more focussed on the SDGs. ments have been tried in both developed and developing country settings, In private sector financial markets, an assessment of a company’s but there is insufficient empirical evidence on their effectiveness across use creditworthiness and efficiency generally begins with an analysis of three cases to make a determination on their advisability. types of information that companies report: income statements - which report revenue and expenditure; balance sheets – which report assets and 5.2 Procurement effectiveness and alignment with liabilities; and cash flow statements – which look at cash availability, the most liquid of financial assets. Private financial instruments (see chapter sustainable development strategies III.B) seek to combine different liquidity and risk return profiles so as to Public procurement frameworks can be used as strategic tools to reinforce maximise the efficiency of financing. Yet, for the most part, public financial sustainable development, as noted in the Addis Agenda. Given public instruments treat public finance on an income or cash basis along with procurement’s weight in most economies and national budgets, improve- consideration of debt and debt sustainability (see chapter III.F). Few gov- ments in the efficiency and effectiveness of this key government function, ernments know the value of their public assets, nor how they those assets beyond mere rule-compliance, are an important lever for improving public are used for sustainable development purposes.37 spending. This is changing as there is a concerted effort to better understand public Governments are increasingly employing public procurement to achieve assets and their effect on public financial sustainability. In July 2019, the policy objectives that are aligned with the 2030 Agenda, such as promot- IMF released the most comprehensive dataset available on public sector ing innovation, sustainability, social inclusiveness and SMEs. Increasing balance sheets.38 Further work has sought to estimate public sector fiscal pressures have further highlighted the potential gains from public balance sheet strength, taking into account different aspects of what gov- procurement reforms.43 As of 2018, all OECD countries reported to have ernments own in addition to what they owe.39 Practitioners at national developed procurement policies towards broader policy objectives, such development banks point out that using well-managed development as a green investment, promotion of SMEs, and innovation. Between 2016 banks as a tool for public investment allows for a more transparent ac- and 2018, there has been an upward trend in the development of policies counting of both the assets and liabilities of the state (see chapter III.F).40 addressing green procurement and, particularly, responsible business 44 There is also interest in instruments that bring together public and private conduct (figure III.A.16). actors in different combinations of responsibility for delivery of public goods and services and with varying degrees of division of financial and Public investment in infrastructure operational risks and financial rewards between the parties. The Task Infrastructure stimulates economic growth and plays a key role in the SDGs, Force wrote extensively about public-private partnerships (PPPs) in with positive spillovers across sectors. The Task Force provided analysis 2018, noting that project and country characteristics and national policy of how to undertake quality investment in infrastructure in its 2017 and priorities would determine which financing model is best suited for specific 2018 reports. investments.41 In its 2017 report, the Task Force identified principles for Given the enormous infrastructure investment needs, public, private, effective use of blended finance and PPPs that were embedded in the domestic and international resources will be required. However, public and Addis Agenda (see chapter III.C).42 private sources of finance are not substitutable. Each has its own incentive A newer form of public-private financial instrument for service delivery is structures, goals and mandates. Meeting infrastructure investment needs the social impact bond. Rather than using a contract to specify services a will require credible financing plans, which can be incorporated into INFFs. private entity will provide, as in a traditional PPP, in a social impact bond Raising public revenues and reallocating existing spending to infrastruc- the government compensates a private partner for achieving specified ture should be key elements of such plans, but may not be sufficient. For outcomes. It then allows a service provider to deliver services towards that countries with moderate debt levels, additional borrowing might be outcome without specifying the specific services to be provided. possible, especially for projects that generate financial returns. Galvanizing A social impact bond is not a bond in the traditional sense. An investor private sector involvement is possible, but the associated fiscal costs and provides upfront financing for the work of a service provider (often an risks need to be carefully managed (see chapter III.B). 45 NGO), but the government only repays the investor if the ultimate outcome Given financing constraints, countries will also need to deliver more is delivered. The advantages of such an approach are that it may allow the infrastructure “bang” for their public investment “buck”. More than a service providers to innovate and try new ways of working that would not third of public investment spending is lost through inefficiency, with be allowed under either regular public service delivery or a PPP arrange- larger efficiency gaps in LDCs and other developing countries.46 Stronger ment, and achieve better outcomes. However, social impact bonds can be infrastructure governance can lead to higher output and efficiency of challenging as standards for success have to be clearly specified. Because public investment while also deterring corrupt behaviour, which poses the population of service recipients is unique in each use, it is incredibly great risks, particularly for large projects. Improving infrastructure gov- difficult to set uniform thresholds or metrics for appropriate outcome ernance could close more than half of the observed efficiency gap. Better 51 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

public infrastructure governance can also help Member States attract identify gaps in public budgetary allocation for disaster risk reduction more private financing for infrastructure, if they desire to pursue blended across sectors. Some countries have established national funds for disaster finance options (see chapter III.C). The IMF Public Investment Management risk reduction and prevention. These provide a mechanism for Govern- Assessment (PIMA) tool helps countries strengthen key infrastructure ments to co-finance investments in risk reduction with the private sector governance institutions (figure III.A.17). The tool offers a comprehensive at national and local levels. Others have applied disaster risk screening framework that helps evaluate Governments’ procedures and processes tools to integrate risk reduction in public investment planning, expen- used to provide infrastructure to the public. diture and procurement. However, no single instrument is optimal for all risk scenarios. Disaster risk reduction financing strategies require a Procurement resilience risk-layered approach. In the extensive risk layer (high probability and low expected loss), investment for risk reduction and prevention is the most Rising economic losses due to disasters and the subsequent cost of cost-efficient. In the intensive risk layer (low probability and high expected recovery and reconstruction can deplete public financing for SDG invest- loss), risk reduction is often financially prohibitive, especially in LDCs and ment. To protect public investments and strengthen stability, disaster risk SIDS. Where risk must be retained, risk transfer schemes, such as insur- considerations should be systematically embedded into domestic public ance, and catastrophe bonds can be more cost-efficient (see chapter III.C). financing, including expenditure and strategic procurement planning. In However, it is critical to integrate measures to incentivize risk reduction most countries, expenditure for disaster risk reduction in public budgets across these tools. is marginal and inconsistent. Domestic public finance, including dedicated budget lines for disaster risk reduction within sectoral budgets, along with Disaster risk reduction financing strategies should be aligned with the disaster-risk-informed public procurement, can be an effective entry point objectives of national disaster risk reduction strategies and incorporated for mainstreaming disaster risk reduction across public investment. into broader planning processes, such as through an INFF. Their implementation should be enabled by clearly defined, comprehensive disaster Several countries have developed hazard maps, risk assessments and risk reduction legal and regulatory frameworks. Technical assistance is risk profiles at national, subnational and local levels which can ensure a available from international partners for countries that need to build the context-specific, disaster-risk-informed approach to public expenditure capacity for developing such strategies and regulatory frameworks. These and procurement. With risk-sensitive budget reviews, countries can

Figure III.A.16 Existence of a strategy/policy to pursue secondary policy objectives in public procurement, 2014 and 2018 (Percentage of countries surveyed)

100

0 2014 2018 2014 2018 2014 2018 2016 2018 2016 2018 Green public Innovative goods Support to SMEs Responsible business Women-owned procurement and services conduct businesses A strategy/policy has been developed at central level Only some procuring entities have developed an internal strategy/policy

Source: OECD. Note: Based on data from 29 countries that answered both the 2018 and one of the 2016/2014 surveys on public procurement.

52 DOMESTIC PUBLIC RESOURCES

Figure III.A.17 Overview of the Public Investment Management Assessment framework

PLANNING 1. Fiscal principles or rules 2. National & sectoral plans 3. Coordination between entities 4. Project appraisal 5. Alternative infrastructure provision

• • IMPLEMENTATION ALLOCATION 11. Procurement 6. Multi-year budgeting 12. Availability of funding 7. Budget comprehensiveness & unity 13. Portfolio management & oversight 8. Budgeting for investment 14. Management of project 9. Maintenance funding implementation 10. Project selection 15. Monitoring of public assets

Source: IMF. issues need to be better mainstreamed into all the assistance provided by Governments to make corrections/changes in the next budget cycle to multilateral institutions. improve the achievement of intended gender equality results. Deliberate integration of gender assessments into policy formulation is Incorporating gender equality possible. Countries with the most advanced GRB practice are effectively Gender responsive budgeting (GRB) enables Governments to plan and mainstreaming gender in each step of their budget planning, execution budget for efforts to support achievement of gender equality objec- and reporting processes and working across all sectors. When done well, tives. Although progress has been made in implementing GRB globally, these actions produce data and learning to inform strategic decisions in significant gaps remain. SDG Indicator 5.c.1, the international standard for the next cycle and increase transparency of gender budget information to GRB, assesses government efforts to put in place gender-focused policies, strengthen government accountability. gender-responsive public finance management systems and budget Alignment of overall budgets is not the only way to advance gender transparency. An analysis of 69 countries and areas reporting on Indicator equality through public expenditure. Some developed countries use public 5.c.1 in 2018 found that 19 per cent fully met those criteria and 59 per procurement to encourage government contracting with women-owned/ cent approached the requirements. The data also revealed a gap in policy led small businesses.47 Indeed, corporations in certain developed implementation. Among the same set of countries, 90 per cent had policies economies, such as the United States of America, have designed policies and programmes in place to address gender gaps, but only 43 per cent that actively seek out women-owned businesses and other diverse suppli- reported adequate resource allocations to implement them. ers as part of their overall business strategies.48 As discussed in chapter Countries implementing GRB have been more likely to issue directives and/ III.B, women-owned/led businesses face constraints in access to capital, or guidelines and use sex-disaggregated data to inform budgeting. Actions human resources, and even an inequitable legal environment. Government that link resource allocations with assessment of outcomes and impact procurement policies can focus on removing barriers and developing the are less common but essential. Fewer countries are conducting ex ante capacity of these suppliers to compete with other businesses. gender impact assessments, producing gender budget statements and/ or gender audits of the budget. When conducted, they can provide insight Tools for procurement performance evaluation into the contributions of gender policies and the expenditures for their A new tool to track the performance of public procurement systems is implementation to meaningful outputs and outcomes. Audits can enable the 2019 revision to the Methodology for Assessing Procurement Systems

53 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

(MAPS). MAPS was originally created by a joint initiative of the World Bank development and poverty reduction. The establishment of new national and the OECD Development Assistance Committee, and was revised to social contracts will be enhanced with transparency and accountability of make it more universal and to support countries in implementing public budgets and more effective service delivery. While there are no univer- procurement systems aligned with the SDGs. It helps countries to conduct sal tools for benchmarking transparency and accountability of budget assessments of their procurement system in order to determine their processes, many developing countries make use of the Public Expenditure performance across 14 indicators in four clusters. Integrity is one of the and Financial Accountability (PEFA) framework.49 PEFA assessments areas that features prominently in the MAPS, reflecting its importance for conducted between 2006 and 2016 (by an average of 27 countries per year) a well-functioning public procurement system. show an upward trend in aggregate PEFA scores over time. Nevertheless, the overall trend in year-on-year performance has been relatively slow 5.3 Transparency and accountability in public finance moving and well below “good practice” scores. Over time, the external scrutiny and audit pillar has consistently had the worst average perfor- Accountable public financial management institutions and systems mance, while the cross- cutting comprehensiveness and transparency pillar play a crucial role in implementation of national policies for sustainable has had the best performance.

Endnotes 1 Data is based on revenues excluding social insurance contributions. 2 2018 data includes fewer observations than 2017, so changes in the median may be only a statistical artifact. 3 OECD, Revenue Statistics 2019 (Paris, OECD, 05 December 2019). Available at https://doi.org/10.1787/0bbc27da-en. 4 ESCWA, "The Arab Financing for Development Scorecard: Domestic public resources", E/ESCWA/C.9/2019/6(Part I), 19 September 2019. Available at https://www.unescwa.org/sites/www.unescwa.org/files/events/files/1901005.pdf. . 5 World Bank, “Platform for Collaboration on Tax: PCT Progress Report 2018-2019 (English)” (Washington, D.C., World Bank Group, 2019). Available at http://documents.worldbank.org/curated/en/702411559936259607/Platform-for-Collaboration-on-Tax-PCT-Progress-Report-2018-2019. 6 See Tax Administration Diagnostic Assessment Tool, “Overview.” Available at https://www.tadat.org/overview. 7 Anna Kochanova, Zahid Hasnain, and Bradley Larson, “Does E-Government Improve Government Capacity? Evidence from Tax Compliance Costs, Tax Revenue, and Public Procurement Competitiveness”, The World Bank Economic Review, vol. 34, Issue 1 (30 May 2018), pp. 101-120. 8 OECD, “Introducing a Commercial off-the-Shelf Software Solution” (Paris, OECD, 2019). Available at http://www.oecd.org/tax/forum-on- tax-administration/publications-and-products/introducing-a-commercial-off-the-shelf-software-solution.pdf. 9 OECD, “Implementing Online Cash Registers: Benefits, Considerations and Guidance” (Paris, OECD, 2019). Available at http://www.oecd.org/tax/ forum-on-tax-administration/publications-and-products/implementing-online-cash-registers-benefits-considerations-and-guidance.pdf. 10 OECD, The Sharing and Gig Economy: Effective Taxation of Platform Sellers: Forum on Tax Administration (Paris, OECD, 2019). Available at https://doi. org/10.1787/574b61f8-en. 11 Lee, Daniel Jeong-Dae, “Cheating the Government: Does Taxpayer Perception Matter?”, ( Bangkok, UN ESCAP); Fredrik Matias Sjoberg and others, “Voice and Punishment: A Global Survey Experiment on Tax Morale”, Policy Research Working Paper (Washington, D.C., World Bank Group, 15 May 2019). Avail- able at http://documents.worldbank.org/curated/en/986411557941098413/Voice-and-Punishment-A-Global-Survey-Experiment-on-Tax-Morale. 12 Wilson Prichard and others, “Innovations in Tax Compliance: Conceptual Framework”, Policy Research Working Paper (Washing- ton, D.C., World Bank Group, October 1, 2019). Available at http://documents.worldbank.org/curated/en/816431569957130111/ Innovations-in-Tax-Compliance-Conceptual-Framework. 13 S.M. Ali Abbas and Alexander Klemm, “A Partial Race to the Bottom: Corporate Tax Developments in Emerging and Developing Economies”, International Tax and Public Finance, vol. 20, Issue 4 (2013), pp. 596-617; Pieter Buyl and Annelies Roggeman, “Do SMEs Face a Higher Tax Burden? Evidence from Belgian Tax Return Data”, Prague Economic Papers, vol. 2019, Issue 6 (2019), pp. 729-747; Francisco J. Delgado, Elena Fernández-Rodríguez and Antonio Martínez-Arias, “Corporation Effective Tax Rates and Company Size: Evidence from Germany,” Economic Research-Ekonomska Istraživanja, vol. 31, Issue 1 (2018), pp. 2081-2099. Available at https://doi.org/10.1080/1331677X.2018.1543056. 14 OECD, “Corporate Tax Statistics: First Edition” (Paris, OECD, 2019). Available at http://www.oecd.org/tax/tax-policy/corporate-tax-statistics-database- first-edition.pdf. 15 Niels Johannesen, Thomas Tørsløv and Ludvig Wier, “Are Less Developed Countries More Exposed to Multinational Tax Avoidance? Method and Evidence from Micro-Data”, The World Bank Economic Review (forthcoming) (24 October 2019). Available at https://doi.org/10.1093/wber/lhz002.

54 DOMESTIC PUBLIC RESOURCES

16 IRS, “Internal Revenue Service Data Book 2018” (Washington, D.C., IRS, May 2019). 17 Niels Johannesen, Thomas Tørsløv and Ludvig Wier, “Are Less Developed Countries More Exposed to Multinational Tax Avoidance? Method and Evidence from Micro-Data”. 18 OECD, “Transparency and Exchange of Information for Tax Purposes: Multilateral Co-Operation Changing the World, 10th Anniversary Report” (Paris, OECD, 24 November 2019). Available at https://www.oecd.org/tax/transparency/global-forum-10-years-report.pdf. 19 OECD, “Transparency and Exchange of Information for Tax Purposes: Multilateral Co-Operation Changing the World, 10th Anniversary Report”. 20 OECD, “Secretariat Proposal for a ‘Unified Approach’ under Pillar One”, Public consultation document (Paris, OECD, 2019). Available at https://www.oecd. org/tax/beps/public-consultation-document-secretariat-proposal-unified-approach-pillar-one.pdf. 21 World Bank, “Platform for Collaboration on Tax: PCT Progress Report 2018-2019 (English)”. 22 Safe harbours typically are aimed at increasing tax certainty, and thus reduce the ability of tax authorities to challenge and audit the taxpayer that has adopted into the generally less complex safe harbour rules. 23 OECD, “Statement by the OECD/G20 Inclusive Framework on BEPS on the Two-Pillar Approach to Address the Tax Challenges Arising from the Digitalisation of the Economy” (Paris, OECD, 2020). Available at https://www.oecd.org/tax/beps/statement-by-the-oecd-g20-inclusive-framework-on- beps-january-2020.pdf. 24 OECD, “Webcast: Update on Economic Analysis and Impact Assessment”. Available at https://www.oecd.org/tax/beps/webcast-economic- analysis-impact-assessment-february-2020.htm. 25 See Box 3, Chapter III.A of Financing for Development: Progress and Prospects 2017, pp. 41. 26 Academics have continued to develop methodologies to estimate IFFs at the national level, see Gilles Carbonnier and Rahul Mehrotra, “Abnormal Pricing in International Commodity Trade: Empirical Evidence from Switzerland”, Discussion Paper No. R4D-IFF-WP01-2019 (January 2019); Cyril Chalendard, Gaël Raballand and Antsa Rakotoarisoa, “The use of detailed statistical data in customs reforms: The case of Madagascar”, Development Policy Review, vol. 37, Issue 4 (14 November 2017), pp.546-563; World Customs Organization, “Illicit Financial Flows via Trade Mis-invoicing Study Report 2018” (Brussels, World Customs Organization, 2018). Available at http://www.wcoomd.org/-/media/wco/public/global/pdf/media/newsroom/reports/2018/ wco-study-report-on-iffs_tm.pdf?la=en. 27 Pierce O’Reilly, Kevin Parra Ramirez, and Michael A. Stemmer, “Exchange of Information and Bank Deposits in International Financial Centres,” OECD Taxa- tion Working Papers No. 46 (Paris, OECD, 28 November 2019). Available at https://www.oecd-ilibrary.org/content/paper/025bfebe-en. 28 See for example the OECD Money Laundering and Terrorist Financing Awareness Handbook for Tax Examiners and Tax Auditors; and ‌the joint OECD-WB publication on Improving Co-operation between Tax Authorities and Anti-Corruption Authorities in Combating Tax Crime and Corruption. 29 World Bank, World Development Report 2017: Governance and the Law (Washington, D.C., World Bank Group, 2017). 30 IMF, Fiscal Monitor: Curbing Corruption, (Washington, D.C., IMF, April 2019). Available at https://www.imf.org/en/Publications/FM/Issues/2019/03/18/ fiscal-monitor-april-2019. 31 Alexandra Leitão, “Corruption and the Environmental Kuznets Curve: Empirical Evidence for Sulfur”, Ecological Economics, vol. 69, Issue 11 (15 September 2010), pp. 2191–2201. Available at https://doi.org/10.1016/j.ecolecon.2010.06.004. 32 IMF, Fiscal Monitor: Curbing Corruption. 33 Michael Johnston, Syndromes of Corruption: Wealth, Power, and Democracy (Cambridge University Press, 2005). 34 World Bank, World Development Report 2017: Governance and the Law. 35 See Conference of the States Parties to the United Nations Convention against Corruption, “Set of non-binding recommendations and conclusions based on lessons learned regarding the implementation of chapters III and IV of the United Nations Convention against Corruption: Note by the Secretariat” (United Nations publication, CAC/COSP/2019/3, 17 September 2019). 36 United Nations, World Public Sector Report 2019 (United Nations publication, Sales no.: E.19.II.H.1). Available at https://publicadministration.un.org/en/ Research/World-Public-Sector-Reports. 37 IMF, Fiscal Monitor: Managing Public Wealth (Washington, D.C., IMF, October 2018). Available at https://www.imf.org/en/Publications/FM/ Issues/2018/10/04/fiscal-monitor-october-2018. 38 IMF, “Public Sector Balance Sheet (PSBS)” (2019). Available at https://data.imf.org/?sk=82A91796-0326-4629-9E1D-C7F8422B8BE6. 39 Ibid. 40 United Nations, World Public Sector Report 2019. 41 Financing for Development: Progress and Prospects 2018, Report of the Inter-agency Task Force on Financing for Development (United Nations publication, Sales no. E.18.I.5). Available at http://digitallibrary.un.org/record/3801757. 55 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

42 Financing for Development: Progress and Prospects, Report of the Inter-agency Task Force on Financing for Development 2017 (United Nations publication, Sales no. E.17.I.5). Available at http://digitallibrary.un.org/record/3801760. 43 OECD, Government at a Glance 2019 (Paris, OECD, 2019). Available at https://doi.org/10.1787/8ccf5c38-en. 44 Ibid.; OECD, Reforming Public Procurement: Progress in Implementing the 2015 OECD Recommendation, OECD Public Governance Reviews (Paris, OECD, 2019). 45 Gaspar, V., Amaglobeli, M. D., Garcia-Escribano, M. M., Prady, D., & Soto, M. (2019). Fiscal policy and development: human, social, and physical investments for the SDGs. International Monetary Fund. 46 IMF, chapter 3 (forthcoming; Washington, D.C., IMF). 47 Sergio Fernandez, Deanna Malatesta, and Craig R. Smith, “Race, Gender, and Government Contracting: Different Explanations or New Prospects for Theory?”, Public Administration Review, vol. 73, Issue 1 (18 December 2012), pp. 109-120. Available at https://doi.org/10.1111/j.1540-6210.2012.02684.x. 48 Keric Chin, The Power of Procurement: How to Source from Women-Owned Businesses (New York, UN Women, 2017). Available at https://www.unwomen.org/digital-library/publications/2017/3/the-power-of-procurement. 49 PEFA was initiated in 2001 by The European Commission, the IMF, World Bank, and the governments of France, Norway, Switzerland, and the United Kingdom.

Infographic Goes Here DOMESTIC AND INTERNATIONAL PRIVATE BUSINESS AND FINANCE Chapter III.B Domestic and international private business and finance 1. Key messages and recommendations

Unlocking private business and finance is one of the greatest bringing together public and private investment, could challenges to achieving sustainable development and reinvigo- mobilize the additional equity financing needed to support rating the economy following the impact of the COVID-19 crisis. innovative companies in less advanced economies. But, as discussed in chapter III.C, country ownership and fair risk-reward On a country level, Governments have several levers that they sharing between public and private partners is necessary for can use to create a thriving business environment and reduce these instruments to be effective. Innovative models, such as investment risks. To help prioritize actions, policymakers auction systems, can be designed to minimize subsidies and should identify and target binding constraints to private optimally use scarce concessional resources. sector development in support of the Sustainable Develop- ment Goals. This could include a range of areas: The first area Major changes are also required in the way private business and is strengthening the legal and regulatory environment. The finance works. The need for a systemic change is evident from the second is providing infrastructure services essential for sustain- lack of sufficient progress in many sustainable areas where com- able development and the functioning of the economy. Despite panies have a large impact, including carbon emissions, gender all the initiatives in this area, infrastructure gaps remain balance, disaster risk, and waste production. Business leaders are considerable between developed and developing countries. increasingly acknowledging that taking sustainability factors into The international community should further help countries consideration will be necessary to achieve long-term financial build the internal capacity necessary to deliver cost-efficient success and ensure the future viability of their companies. How- and resilient infrastructure solutions, including developing ever, turning this awareness into action requires the following: “investible projects” when feasible. The third is addressing Adjusting corporate governance, aligning internal financial constraints, particularly affecting micro, small and incentives (such as remuneration criteria for CEOs), and medium-sized enterprises. This requires harnessing techno- addressing the persisting short-termism in capi- logical advancements, for instance to overcome data gaps for tal markets; credit risk assessment. Making companies more accountable. This is impossible Building an enabling business environment, however, may not without meaningful information on companies’ social be sufficient to mobilize investment at the speed and scale and environmental impact. Reporting requirements required to achieve the sustainable development goals (SDGs), for large corporates need to include a common set of particularly in countries most in need and in sectors key for sus- sustainable metrics regardless of their materiality impact. tainability. Identifying the types of financial instruments most Through its analytical work, the Inter-agency Task Force likely to deliver results given the local context will again require on Financing for Development can facilitate convergence a proper assessment of the key constraints to investment. This between reporting initiatives and the emergence of chapter lays out a range of tools and financial instruments that harmonized and comparable data. This is key to support can be used to overcome some of the impediments to private sustainability-driven investor initiatives, such as the Global investment. For instance, international vehicles can be used to Investors for Sustainable Development (GISD) Alliance; manage currency, disaster and political risks, in part through Enabling people to use their money to support changes their ability to diversify across countries and risks. Smartly they believe in. Every survey shows strong appetite for structured private equity and venture funds, including those this from individual investors. However, individuals do 59 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

not always have the possibility to do so, either because no one asks As noted in chapter I, investment rates are currently below historical aver- them questions about their sustainability preferences; they cannot ages, despite record low interest rates. The outlook for private investment find credible investment products; or because they are sold products has weakened over the last decade amid global uncertainties and declining marketed as sustainable with no actual impact. This needs to change. investor confidence.1 Investment growth has been particularly weak in Investment advisors should be required to ask their clients about areas of traditional investments, such as machinery, construction and other their sustainability preferences along with other information they tangible assets. The COVID-19 crisis further clouds investment prospects. already request; Private investment in infrastructure projects in developing countries has Establishing minimum standards for investment products to be also been low relative to historical averages, at less than $100 billion a year marketed as sustainable. A common definition of what constitutes between 2016 and 2018. While infrastructure commitments increased 14 sustainable development investing would be an important step per cent in the first half of 2019, the yearly figure will remain well below towards setting such standards. International platforms, such the $160 billion peak reached in 2012.2 In particular, since 2014, invest- as the United Nations, need to be leveraged to develop a shared ment has fallen in sectors with more limited financial returns, such as water, understanding at the global level, and avoid the proliferation of sanitation and hygiene, and education. Investment in the generation, competing and possibly conflicting standards. transmission and distribution of electricity has remained flat, while invest- The chapter starts by reviewing investment trends and the different ment in telecommunications, transport and agriculture has increased.3 components to create an enabling business environment. The chapter then This broader trend is mirrored in FDI, which has experienced anaemic examines financial instruments that can be used to mobilize additional growth since 2008. Adjusted for short-term volatility and fluctuations private investment. It concludes by exploring ways to transform private caused by one-off factors, such as tax reforms, FDI has averaged only 1 per business practices towards more sustainability. cent growth per year this decade, compared with 8 per cent in 2000-2007, and more than 20 per cent before 2000 (figure III.B.1). In 2019, global FDI remain flat at an estimated $1.39 trillion.4 In 2020, the downward pressure 2. Investment trends on FDI caused by COVID-19 is expected to be -5 to -15 per cent (compared There are several trends in private investment which are important for to previous forecasts projecting marginal growth in the underlying FDI achieving sustainable development and the SDGs. These include (i) low trend for 2020-2021). The impact on FDI would be concentrated in those investment growth in traditional tangible assets and infrastructure, with countries that are most severely hit by the epidemic, although negative higher growth in investment in digital technology; (ii) weak foreign direct demand shocks and the economic impact of supply chain disruptions could investment (FDI), but a shift from developed to developing countries; and affect investment prospects globally. Lower profits from many multina- (iii) a greater interest in sustainability, with a focus on climate-related risks. tional enterprises would also translate into lower reinvested earnings (a

Figure III.B.1 FDI in ows and the underlying trend, 1990–2018 (Indexed, 2010 = 100)

FDI underlying trend, average annual growth rate 1990s: 21% 2000-2007: 8% Post-crisis: 1%

150 FDI 140 130 120 110 100 90 80 FDI underlying trend 70 60 50 40 FDI underlying trend 30 20 10 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Source: UNCTAD, World Investment Report 2019.

60 DOMESTIC AND INTERNATIONAL PRIVATE BUSINESS AND FINANCE

5 major component of FDI). Figure III.B.2 Technological change has been a driver of the underlying trend of low FDI. Market share of sustainable, responsible and impact investment (Trillions of United States dollars) Digitalization has enabled multinational enterprises to generate sales abroad with limited local presence. It has also facilitated a shift of international production from tangible cross-border production networks to intangible Investor Market Size = $268.8 trillion value chains and non-equity modes of operations, such as licensing and contract manufacturing. This is reflected in the much faster growth of trade in services and international payments for intangibles (royalties and licensing Sustainable and Responsible fees) than for tangible production indicators such as FDI and trade in goods. Investment in selected The growth of foreign sales of the top 100 multinational enterprises outpaces economies = $30.7 trillion growth in foreign assets and employees, suggesting that these enterprises are reaching overseas markets with a lighter operational footprint, which might create challenges for local authorities to collect taxes (see chapter III.A). Impact Investment Another long-term trend is the growing share of FDI flows towards (based on self-reporting developing economies. In the ten years prior to the 2008 crisis, developing data) = $0.5 trillion economies attracted 30 per cent of global FDI flows, on average. This percentage increased to about 45 per cent in the last ten years, and exceeded 50 per cent in 2018 and 2019. Yet, these flows have not benefitted all countries equally. While certain regions have been able to attract more investment, particularly in Central Africa, South-East Asia and East Asia, in other regions, FDI declined below pre-crisis levels. Source: UN DESA based IFC report on creating impact: the promise of impact investing. Notable changes are also happening in investment practices. Sustainability Last year, 115 economies implemented additional regulatory reforms to issues are receiving greater consideration, although the impact of such ease doing business.11 investing is often uncertain. Investment strategies that focus on profit Nonetheless, other impediments remain and there is space for improve- maximization, while considering the impact of environmental, social and ment in most countries. One such area would be removing barriers that governance (ESG) factors have increased by 34 per cent between 2016 and deter women’s entrepreneurship and labour force participation. Laws 2018 to reach over $30 trillion of investment assets across major developed limit women’s property rights in 40 countries, and women cannot run 6 markets. ESG-based indices have mushroomed, increasing by 14 per cent a business the same way as men in 115 countries.12 Increasing female 7 in the twelve months through June 2019. Green bond issuance reached labour force participation could lead to economic gains of an estimated 10 new heights in 2019, at about $250 billion, representing close to 50 per to 80 per cent of gross domestic product, depending on the initial value of 8 cent increase from 2018. Yet this still represents only a small part (about 3 female labour force participation.13 per cent) of the fixed-income market issuance. Lowering the administrative burden of regulatory compliance could also More funds have also been allocated to impact investment, which aims to help encourage domestic entrepreneurs to leave the informal sector, which generate positive social and environmental impact alongside a financial represents about 70 per cent of employment in emerging market and 9 return (i.e., “doing good” as an explicit investment objective). Respon- developing economies. This could translate into significant productivity dents to a 2018 industry survey, who collectively manage $239 billion in gains since the average informal firm in these economies is estimated to impact investment assets, invested over $33 billion into more than 13,000 be only one-quarter as productive as the average firm operating in the impact investment projects, primarily in energy, microfinance and finan- formal sector.14 By the same token, strengthening trust in the public 10 cial services. Yet, while sustainability-aligned investment strategies administration could encourage entrepreneurs to start new businesses in and impact investment assets have increased, they still represent a small the formal economy. portion of overall financial assets (figure III.B.2). Policymakers can also improve the efficiency of business facilitation measures. For example, online information portals and single windows have been used to attract foreign investors by making information more 3. Private sector development transparent. However, the quality of information portals varies. A review conducted in 2017 shows that more than a third of portals contain only the strategies bare minimum amount of information to qualify as business registra- To thrive, private companies need an enabling business environment, tion portals, and only about 10 per cent of portals contain all (or almost including stability, efficient infrastructure services, access to finance, and all) the types of information needed in order to register a business or legal and regulatory frameworks. investment.15 Business facilitation measures, along with any reduction in regulatory 3.1 Building a conducive legal and regulatory environment standards, needs to be coherent with sustainable development objectives. Countries have made strides to reduce administrative hurdles for compa- To maximize private sector contributions to sustainable development, nies, as reflected in the falling cost of starting a business (figure III.B.3). these measures should go hand in hand with protecting labour rights and 61 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Figure III.B.3 Cost of starting a business (Percentage of income per capita) 300

250

200

150

100

0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

LDCs MICs Developed countries

Source: World Bank, Doing Business database.

environmental and health standards, and disaster risk reduction standards, to operate. Figure III.B.4 shows that the perceived infrastructure quality regulations and legislation, even if these measures may imply increasing gap between developed and least developed countries (LDCs) has grown, the cost of doing business. For example, some countries are strengthen- not shrunk, over time according to surveys of business executives in more ing rules against harmful pesticides in agriculture, raising minimum than 130 countries. standards in building codes, and establishing new protected areas (e.g., Well-developed infrastructure plans are needed to address these gaps. They Palau banned commercial fishing in 80 per cent of its marine territory to should include adequate stakeholder consultations and incorporate climate protect its ecosystem). These laws raise the costs for businesses, but can be impact, disaster risk assessments and resilience, as well as gender assess- necessary to achieve the SDGs, underscoring the importance of developments in order to provide a long-term vision. This vision will allow countries ing regulations in an integrated manner (such as through an integrated to avoid having costly stranded assets later on, such as coal-fired power national financing frameworks (INFF), which includes an analysis on plants, or essential infrastructure assets unable to function during and trade-offs). International organizations can support countries in advancing after natural disasters.18 Each dollar invested in infrastructure resilience their objectives in these areas. For example, the ILO-IFC Better Work is expected to deliver a $4 benefit through avoided repairs and disruptions Programme in the garment industry help governments to improve labour and lower maintenance costs in low- and middle-income countries.19 laws, suppliers to comply with international standards, and multinationals to become more responsible.16 Making the right decision is critical as infrastructure assets typically last for decades and upfront costs should be weighed against operational costs over An enabling business environment also requires competition policies to the asset lifecycle. In fact, infrastructure investment paths compatible with facilitate entrance of new businesses and avoid monopolistic behaviours full decarbonization have been found to cost no more than polluting alter- by dominant firms. Growing market concentration has been greatest in the natives when accounting for the lifecycle cost of infrastructure assets.20 digital space, where further increase in market power by already dominant firms could deter investment and innovation, as well as exacerbate Technological advancements can help project prioritization and planning, inequality.17 Policy measures could include stricter rules for mergers with for instance, through data analytics and enhanced project management. detrimental impact on competition, for instance when incumbents buy For example, SOURCE is a customizable software designed to help Govern- rising competitors (see chapter II). ments prepare, procure and implement their infrastructure projects, which is supported by multilateral development banks (MDBs). 3.2 Providing infrastructure services while leveraging Technological change is also influencing the choice of infrastructure by impacting costs. For example, the cost of electricity from solar PV decreased technology 77 per cent between 2010 and 2018,21 making clean energy competitive Another lever for policymakers to support private sector development is with fossil fuel alternatives, as demonstrated by the vast majority of new the provision of efficient infrastructure services, which companies rely on electricity-generation projects using renewable-energy sources (more 62 DOMESTIC AND INTERNATIONAL PRIVATE BUSINESS AND FINANCE

Figure III.B.4 Perceptions of infrastructure quality (Score 1-7 (best))

5.06 Developed countries 4.56

3.72 Middle-income countries 3.02

2.58 LDCs 2.29

1.00 2.00 3.00 4.00 5.00 6.00 7.00

2017-2018 2007-2008

Source: UN DESA, based on The World Economic Forum Global Competitiveness Reports (World Economic Forum, 2019). than ninety per cent for projects with private finance).22 However, to Private investment is thus not always the answer to all infrastructure make solar energy viable in frontier markets, regulatory changes and challenges. The public sector still accounts for 87 to 91 per cent of reforms need to accompany technological advancements. Countries could infrastructure investment spending in developing countries.26 Public in- benefit from international support in this area (e.g., the Scaling Solar vestment will continue to dominate infrastructure spending—particularly initiative from the World Bank Group).23 in sectors with limited cash flow potential to repay the private investor, Technology can also enable innovative business models, such as pay-as- such as sanitation and education—when affordable access for all has to be you-go systems where a service provider leases equipment (e.g., a solar provided. While financial engineering can be used to create instruments home system) to a consumer. This allows consumers to pay regular small that attract private investment even in these cases (see section 4 below), it amounts—via mobile phone, for instance—to obtain access to electricity can be cheaper and more efficient to use public finance. without having to make a costly upfront investment. It creates a reliable Technical support can help developing countries determine the most revenue stream for the service provider, and also reduces collection costs cost-effective capital structure (e.g., public versus private financing (since payments are automated and the system is controlled remotely), models) and build institutional capacity for project planning, preparation which makes it suitable in rural areas.24 Impact-based business models and negotiation. In addition to existing technical assistance programmes, are also emerging. For example, a firm could improve the energy efficiency private sector specialists could offer to support developing countries in of private households and be repaid on-bill through the effective energy building a pipeline of viable projects targeted towards private investors. savings.25 This would be a more efficient solution than having individual This could include support from both developed- and developing-country homeowners figure out what is the most efficient investment to reduce experts, with some of the support possibly through pro bono assistance their energy bill. It would also overcome liquidity and credit constraints from a network of infrastructure specialists (e.g., “infrastructure experts for households that would not need to put the funds in upfront. Similarly, without borders” in the same fashion as “tax inspectors without borders”). technology can enable the involvement of private companies in public services delivery (e.g., ridesharing systems in urban areas) (see chapter II). Public policies can, nonetheless, be used to unlock such potential (e.g., 3.3 Addressing financial constraints tax incentives, urban planning), as well as to manage associated risks (e.g., Without adequate financial services, individuals and companies are unable minimum quality standards, competition policies, information privacy). to fully participate in the economy. In recent years, fintech developments— Private investment can also be mobilized in large infrastructure projects, and particularly mobile money services—have contributed to a rapid for instance through public-private partnerships (PPPs). Structuring these increase in account ownership and facilitated financing for micro- small and partnerships is complex, however, and requires expertise often lacking medium-sized enterprises (MSMEs). Nonetheless, about 1.7 billion adults in public administration. While PPPs can bring cost-efficient solutions in remain unbanked, and important access gaps persist between men and certain contexts (Financing for Sustainable Development Report 2018), women, poorer and richer households and rural and urban populations. For they are often associated with fiscal contingent liabilities, which needs to example, the financial inclusion gender gap in developing countries be properly managed. remained at 9 percentage points in 2017, unchanged since 2011.27 Active 63 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

account usage, as measured by a minimum of one deposit or withdrawal per The slow increase in account usage suggests that not all newly opened ac- year, also increased at a slower rate than account ownership (figure III.B.5). counts meet their owners’ needs, be it in terms of affordability, ease of use or effectiveness for routine transactions. It also points to the need for addi- Figure III.B.5 tional enabling factors—particularly in the case of fintech services—such Account ownership and usage, 2011–2017 (Percentage of adults age 15 and above) as infrastructure, secure digital identity systems, and digital and financial 80 education. An appropriate regulatory framework is also important, not only for supporting innovation but also to protect the economy against the risk of overindebtedness (for the role of fintech in financial inclusion, see 70 68 also chapter III.G). 62 60 At the same time, about 131 million or 41 per cent of formal MSMEs in 53 developing countries have unmet financing needs.28 Globally, MSMEs 51 52 50 receive less credit, and their loan applications are more frequently rejected 47 than those of large firms (figure III.B.6). A much greater share of MSMEs

40 identifies access to finance as a major constraint in comparison to large firms, and women-owned/led firms are more often affected by financing constraints. These discrepancies are more pronounced in LDCs, where 30 financial sectors tend to be less developed. 23 27 27 20 Traditional bank lending to MSMEs has long been hindered by a lack of instruments for overcoming asymmetric information, such as credit histories, 10 accounting data and traditional collateral. Another hurdle is the high cost involved in due diligence relative to the size of the loan. In many developing countries, less competitive banking sectors have also played a role, as 0 2011 2014 banks can charge higher prices for services and have fewer incentives 2017 Account ownership Active account usage to service marginal customers. Financing instruments such as factoring Saved in an account and leasing have gained ground, most likely because they mitigate some of these challenges. For example, leasing allows the lender to retain Source: World Bank, Global Findex Database. ownership of the financed good.29 Some countries have also successfully Note: Active account usage means at least one deposit or withdrawal over the past introduced movable collateral frameworks that enable MSMEs to use their 12 months. assets (such as equipment and receivables) as non-traditional collateral.30

Figure III.B.6 Percentage of rms whose recent loan application was rejected, ca. 2013 (Percentages) 20

0 Small (5-19) Medium (20-99) Large (100+) Female-led Male-led

Developing Countries LDCs

Source: UN DESA, based on World Bank, Enterprise Surveys. Notes: Data from the most recent survey year was included for each country (between 2006 and 2019, with a mean of 2013). Aggregates are calculated as averages of country data. 64 DOMESTIC AND INTERNATIONAL PRIVATE BUSINESS AND FINANCE

Box III.B.1 Cost of remittances Global flows of remittances—mainly wages that migrant workers transfer to their families—are projected to have reached $707 billion in 2019, a nominal increase of 3.5 per cent from 2018.a The average cost of sending $200 dollars has continued to stagnate at about 7 per cent since the end of 2017 across all regions, well above the 3 per cent target in the 2030 Agenda for Sustainable Development and the Addis Ababa Action Agendas. This has a large impact on receiving families, as each percentage point in transaction costs deprives them of about $5.5 billion per year. The costs, however, vary substantially across remittance corridors. According to the World Bank’s indicator for the cheapest available transfer options, 60 per cent of all remittance corridors had options costing less than 5 per cent of the transfer amount at the end of 2019. By contrast, the cost of transfers remains particularly high in sub-Saharan Africa, at about 9 per cent on average (figure III.B.7). Fintech companies, such as mobile operators, systematically charge lower fees than conventional money transfer operators and banks, and have been instrumental in lowering costs in these corridors.b Apart from mobile money, blockchain technology could address some of the shortcomings of the traditional payment system, including access, speed of clearing and settlement, and transaction costs; however, issues of compliance with anti-money laundering and countering the financing of terrorism (AML/CFT) regulations still need to be addressed.c The high fee for transfers in some corridors can be related to the cost of compliance with AML/CFT regulations, and in some countries, the loss of correspondent banking relationships. Promoting financial inclusion can help combat the high cost in some countries, as cash remittances can be onerous, in part due to AML/CFT compliance. Many non-bank/fintech solutions rely on banks to meet these regulatory requirements, which limits their use to banked customers. The structure of the remittance market can also keep the cost of remittances stubbornly high—for instance, when exclusivity agreements curb competition and act as a powerful barrier to entry. Even when low-cost services are already present in a country, there are other aspects that impede people from adhering to them, including accessibility, awareness, literacy and trust. Countries face different challenges, ranging from poor information and communications technology infrastructure to a strong cash culture, which calls for policy responses tailored to each country-specific context (see chapters II and III.G). Continued work is needed at the global level to agree on common standards and improve information sharing (including digital IDs) to facilitate compliance with AML/CFT regulations for cross-border payments and counter the decline in the number of correspondent banking relationships, which has had a significant impact on remittance service providers’ ability to access banking services .

Figure III.B.1.1 Average total cost for sending $200, by region, 2015–2019 (Percentage)

4 SDG target 3% 3

0 East Asia and Europe and Latin America and Middle East and South Asia Sub-Saharan Africa the Paci c Central Asia the Caribbean North Africa

Q4 2015 Q4 2016 Q4 2017 Q4 2018 Q4 2019

Source: World Bank, Remittance Prices Worldwide. a Dilip Ratha and others, “Data release: Remittances to low- and middle-income countries on track to reach $551 billion in 2019 and $597 billion by 2021”, World Bank, (Washington D.C., World Bank, October 16, 2019). b Hongjoo Hahm, Tientip Subhanij and Rui Almeida, “Finteching Remittances in Paradise: A Path to Sustainable Development”, Working Paper ESCAP/MPFD/WP/19/08 (October 2019). c OECD, “Can blockchain technology reduce the cost of remittances?” (Paris, forthcoming).

65 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

More recently, fintech solutions offer promise in helping MSMEs overcome to materialize, but even countries with strong enabling business the financing gap, through the use of greater access to data for credit risk environments often fail to attract private finance to sustainable evaluations, peer-to-peer lending and crowd-funding platforms, supply development priorities. There are a range of reasons for this, including chain financing, and non-cash merchant payments (see chapter III.G). The the following: use of such services can also create positive feedback loops, as electronic Low expected returns. Despite having positive development impacts transaction histories can strengthen the information base for risks assess- and social benefits (e.g., affordable energy or water for all), some in- 31 ments and better credit ratings can unlock access to additional services. vestments (which might be profitable) might not be lucrative enough Governments can identify gaps and implement a coherent set of policies to to attract private finance on commercial terms; promote solutions that improve financial services to underserved individuals High project/business/micro risks. Entrepreneurs and companies may and companies through national financial inclusion strategies, as part of in- struggle to attract the risk capital they need to grow, for instance if tegrated national financing frameworks. Such financial inclusion strategies there is no established market for equity financing; have been adopted or are being developed by at least 69 countries.32 Some countries have begun to review past progress and implementation gaps to Liquidity and credit constraints. Such constraints can impede lending adjust their strategies to new developments, including fintech. The interna- and limit investment, particularly when local financial institutions are tional community should help countries in developing these strategies.33 relatively underdeveloped; Small scale. Large investors require scale to invest as transaction costs 3.4 Entrepreneurship and investment promotion on smaller deals can become prohibitive, while many investment opportunities are small by nature (e.g., MSMEs); Policymakers can also take a more active role to support private sector development. Governments can, for instance, help stimulate entrepre- External/macro risks. Investors are particularly wary of risks they neurship by sponsoring incubators in universities, granting seed capital cannot quantify and/or control. These include political risk and policy to start-ups and providing technical support to entrepreneurs.34 For changes affecting project viability, volatility of local currencies, or example, the United Nations Conference on Trade and Development climate-related catastrophes. (UNCTAD) has provided training to entrepreneurs and MSMEs through its Governments have a range of instruments to help solve some of these Empretec capacity-building progamme. challenges when financial markets do not provide solutions on their Governments have also used investment promotion agencies or industrial own. Unlike policies which reduce risks (e.g., strengthening the en- parks and special economic zones (SEZs) to attract foreign direct investment. abling environment discussed above), these instruments tend to share There are currently 5,400 zones across 147 economies.35 Most zones offer risks between the public and private sectors. However, such public tax incentives and business-friendly regulations regarding land access, per- involvement is not without challenges, which have been discussed mits and licenses or employment rules. However, results have been mixed. in earlier reports of the Inter-agency Task Force. Among others, they Only about half of investment promotion agencies worldwide believe the include risks of (i) private sector involvement when it is not the most zones in their country have given a significant boost to FDI attraction, and cost-efficient solution; (ii) perverse incentives, such as excessive few countries systematically assess the performance and impact of SEZs.36 risk-taking by financial institutions; (iii) overly generous risk-reward sharing arrangements/subsidies for private investors, with the risk of At the same time, new types of SEZs are emerging, including ones that the public sector holding the risk and the private sector earning all of focus on new industries, such as high-tech, that move beyond trade- and the returns (and sometimes diverting public funds from other needs); 37 labour-intensive manufacturing activities of traditional SEZs. These zones (iv) overleveraging of private companies (i.e., increasing the debt can create linkages between firms to help stimulate technological develop- leverage of a company to a point where it jeopardizes its long-term ment and local innovative capacities. There is also a case for building SDG viability). model zones to attract investment in SDG-relevant activities, promote linkages with domestic activities and advocate for high ESG standards. For instance, Figure III.B.7 lays out instruments that can tackle the challenges, and fiscal incentives can be conditional not only on employment, investment or some of the risks and opportunities linked to them. The figure includes export performance, but also on social and environmental indicators.38 This three general types of instruments, those that (i) boost financial returns requires being able to assess the sustainability characteristics of FDI—for for investment with positive externalities; (ii) increase the supply of instance, through country-specific sustainability indicators that can help financing (either directly or through financial institutions); and (iii) Governments prioritizing FDI into key SDG sectors.39 FDI promotions policies manage risks through diversified portfolio approaches. These interven- should not be considered in isolation but in the context of broader strategies re- tions can be warranted to kick-start markets and create investment garding sustainable development and, in particular, innovation (see chapter II). opportunities with risk-return characteristics that meet different investor requirements.40 In each area, policymakers need to understand the existing constraints; the tools available; and the risks, opportunities, and trade-offs within the local context. This assessment could be done when 4. Financial instruments to mobilize countries are developing integrated national financing frameworks (see also chapter III.C for blended finance principles). Opportunities and private finance challenges associated with each of the instruments used to mobilize An enabling business environment may not be sufficient to mobilize private finance for sustainable development are further developed in private finance for sustainable development. Reforms may take time this section. 66 DOMESTIC AND INTERNATIONAL PRIVATE BUSINESS AND FINANCE

Figure III.B.7 Schematic overview of instruments to mobilize private nance

Selected instruments to mobilize private nance

Liquidity and Low returns Project/business risks Small investment scale External risks (political, credit currency, disaster)

Challenges constraints Pioneer interventions Concessional loans (e.g. PE/VC) Co-lending/ investing platforms and viable gap Line of credits to funding mechanisms Risk-return enhancing nancial Insurance and risk institutions and mechanisms (e.g. rst loss) Securitization guarantees Instruments credit guarantees

Make investments with Increase access to growth Leverage local Create investment Transfer risk to a party positive development capital for local companies nancial sector channels for investors that can diversify it or impact nancially viable capacity to better match it Allocate subsidies through Narrow the gap between originate deals Bundle investments competitive mechanisms perceived and real risks to create scale Opportunities

Encourage private investment Produce unbalanced risk- Fail to bene t Delay actions needed to where public nance is more reward sharing mechanisms underserved segments reduce risks optimal with the private sector (e.g. stable political and Lower lending macroenvironment) Risks Create market Promote excessive nancial leverage standards to distortions generate volume Mispricing

Source: UN DESA. 4.1 Concessional loans and grant co-financing 4.2 Private equity and venture capital Subsidized lending is often used to reach underserved market segments. It Capital markets are a key source of equity financing but remain under- can also promote pioneering projects that aim to help create markets, with developed in many countries and mostly inaccessible to smaller businesses. temporary assistance. For example, microfinance firms generally depend Private equity and venture capital (PE/VC),42 are important sources of funds on subsidies to cover the difference between the cost of providing services for entrepreneurs and promising companies (which otherwise often rely and the revenues generated. While the subsidies are often temporary for on friends and family for initial capital). PE/VC fund managers make direct pioneer projects, they may be more long term in nature in other cases. A investment in unlisted companies, with the aim of bringing capital, technical review of more than a thousand microfinance institutions found that such and managerial expertise to raise the firm’s value and make a profit at the subsidies represent, on average, 13 cents per dollar loaned, and tend to be exit (e.g., by selling the company to another industry player after a few years). 41 enduring rather than being phased out over time. These markets also remain underdeveloped in many countries. For ex- Assessing the level of concessionality required to attract the private part- ample, in Africa, about half of respondents to an industry survey indicated ner is more of an art than a science. The availability of subsidies should not the limited number of established fund managers as a deterrent to invest- undermine policy efforts to make lending to underserved segment more ment.43 When these markets do not develop on their own, development self-sustainable. In addition, beyond a certain level of subsidy, pure public finance institutions can catalyse market creation. For instance, they can finance is likely to be more efficient than trying to mobilize private finance strengthen the local PE/VC ecosystem through pioneer interventions and by any means. When subsidies are used, they should be just sufficient to help link private investors with companies seeking growth capital. induce private actors to participate in high-value activities. One way to ad- The potential is considerable. Globally, private equity funds hold about dress this is to make grants part of a bidding process. For example, viability $2 trillion in cash, which is more than twice the 2012 level.44 While the gap funding mechanisms have been created in infrastructure sectors amount invested in emerging markets almost doubled between 2015 and to make projects financially attractive without raising user fees beyond 2018 to reach $70 billion, it still represents only a fifth of investment made affordability limits. In these mechanisms, the eligible private sector bidder in the United States of America alone (i.e., $375 billion), and is mainly requiring the lowest subsidy is selected. Other mechanisms to assure directed to a few large economies, such as Brazil, China, India and South efficient subsidy allocation are programmatic approaches (predefined Africa. PE/VC investment level is particularly low in Africa, where only $2.5 programmes in a segment open to all applicants at preset fees), and billion has been invested annually over the last five years.45 negotiations under strong governance (e.g., separate teams managing concessional funds and benchmarking levels of concessionality compared While PE/VC investors may be interested in looking outside traditional to projects in similar industries and countries). markets for more attractive returns, to date, high perceived risks in developing countries have impeded investment. Development finance 67 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

institutions can help in these cases. They can accompany investors in more 4.3 Line of credit to financial institutions and credit challenging markets and strengthen their collaboration at the country guarantees level to remove barriers to private investment.46 Private finance can also be constrained by the lack of liquidity of local Public authorities might also be willing to co-invest in privately managed financial institutions. To address this constraint, development banks PE/VC funds to support the local economy and job creation or other public provide these institutions dedicated credit lines for on-lending. These lines goods. If the objective is to support innovative business models, the right of credits can be accompanied by credit guarantees that partly cover local instrument is equity financing through a diversified portfolio. Unlike grants banks against losses on loans targeting underserved market segments. or subsidized loans, equity financing allows the public to capture the upside Governments and development partners have widely used these instru- potential, which could then be reinvested in public goods. While some of the ments to spur lending to MSMEs and sustainable activities (e.g., green businesses seeking investment may ultimately fail, the gains from a few win- investment) through local partners with greater local knowledge. In 2017, ners should compensate the failures of the losers. Indeed, this is the model intervention in the banking and financial services sector, primarily through that VC firms and other fund managers have used profitably for many years. guarantees and credit lines, represented roughly 30 per cent of all private When the perceived risk is disproportionate vis-a-vis the expected returns, finance mobilized through official development finance interventions (see public returns can be subordinated to private returns in co-investment schemes box III.B.3).49 as a way to attract private investment while still benefiting from potential Development financing institutions have begun to examine the impact 47 upsides (see box III.B.2). More innovative models could also be tested. For of lines of credit, although limited data on sustainable development example, public money could be used to make equity investment in firms that impact makes this difficult to assess. There are several risks which could generate positive externalities (e.g., quality jobs) but fail to attract private in- impact the effectiveness of this type of instrument. First, local financial vestors. Such investment could be structured to cap the entrepreneur’s upside, institutions could gain from cheaper funding, but not change their so that entrepreneurs will not use public money unless they really need it.48 lending practices. Second, the mechanism could crowd out other sources Nonetheless, finding the appropriate risk-reward sharing mechanism is of domestic finance. Third, it could create macroeconomic imbalances or difficult, and so is finding the right size of public intervention. One objec- overindebtedness, especially when the lending is in foreign currency. tive is to keep the interests of all investors and the fund manager aligned. Precautions thus need to be taken. First, development finance institu- Another is to avoid creating market distortion—for instance, for other tions need to ensure that sufficient information is available on the final investors who might not benefit from this kind of risk-reward mechanism. beneficiaries of these credit lines (i.e., borrowers from the local banks), for This requires transparency and monitoring systems in place to assess the instance by requiring appropriate reporting from these banks. Second, the results of public support mechanisms, as well as innovative mechanisms, additionality of credit lines needs to be carefully monitored and assessed such as the bidding process discussed above. to ensure that development bank interventions are contributing to better Another risk associated with private equity has been the intensive use of access to finance for targeted segments and not merely replacing what debt leverage to enhance investment returns. Although the lower access to local financial institutions would have done anyway. A reward system debt finance in most developing countries mitigates such risk, the use of could be introduced to address such risk. For example, the Affirmative leverage should be monitored, since excessive risk could make companies Finance Action for Women in Africa (AFAWA) initiative from the African less resilient to economic downturns and also have systemic implications. Development Bank offers preferential terms to institutions performing well on predefined objectives regarding women’s access to financing. Third, development banks should provide credit lines in local currencies whenever Box III.B.2 possible and ensure that credit lines do not result in foreign currency risks Ontario Venture Capital Fund been passed on to MSMEs with no capacity to manage them. Finally, credit In 2008, the Government of Ontario in Canada decided to revive its line effectiveness also depends on complementary measures that make venture capital ecosystems that had suffered from poor returns. To MSME lending sustainable in the long run. These measures include regula- do so, a joint initiative was launched with institutional investors. tory reforms to improve information on borrower creditworthiness. This last A fund of funds managed by a third-party investor was created to area is changing dramatically due to advances in fintech (see chapter III.G). invest in local venture capital and growth equity funds. The public sector invested $90 million, while institutional investors contributed 4.4 Co-lending / investing platforms $115 million. The Government agreed that its capital would be “first While some investments are best met by local institutions, institutional in, but the last out”. This meant that public money was invested first. investors, such as pension funds and insurance companies, hold trillions Returns from realized investments were first distributed to private of dollars in assets that could support the long-term investments needed investors until a predefined return rate was achieved. Any returns for sustainable development, particularly investments with positive cash above that level of returns were shared between the public and flows to repay the investors. However, one of the challenges in mobilizing private investors. The subordination of government capital made these investors is the lack of scale in many projects, especially in smaller the proposal attractive for private investors. The initiative created countries. Most institutional investors cannot afford to spend resources on a funding source for a new generation of venture capital managers screening small transactions. Financial instruments that bundle smaller in Canada, while generating returns for both private and public inves- deals together could help provide a solution. Another solution would be to tors. Similar structures could be considered in developing countries. strengthen collaboration between global and local institutional investors.

68 DOMESTIC AND INTERNATIONAL PRIVATE BUSINESS AND FINANCE

Box III.B.3 Amounts mobilized from the private sector Recent data from the Organization for Economic Cooperation and Development (OECD) highlight that the amounts mobilized from the private sector by bilateral and multilateral development finance providers reached $48.4 billion in 2018, representing a 28 per cent increase compared to 2017. These include the amount mobilized by both concessional and non-concessional official development finance interventions. Fifty-five per cent of the amounts mobilized targeted energy and banking sectors, while only 5.6 per cent went to projects in social sectors.a Guarantees play a significant role, representing 39.5 per cent of the private finance mobilized for development during 2012-2018. Figure III.B.3.1 also shows the relative importance of each type of instrument.

Figure III.B.3.1 Amount mobilized from the private sector by instrument (2012–2018) (Percentage)

Simple co- nancing, 6.4 Shares in Collective Investment Vehicles, 15.6

Guarantees, 80.9 Direct investment in companies and SPVs, 36.3

Credit lines, 29.8

Syndicated loans, 36.1

Source: OECD. Note: Technical assistance is not included, but work is ongoing to capture private nance mobilized through this instrument.

In an effort to enhance transparency and accountability, 27 multilateral development banks (MDBs) and development finance institutions (DFIs) have also reported yearly on their respective mobilization data of private capital since 2016. These institutions follow a common methodology to calculate and jointly report the private capital mobilized in their project activities. The latest report on 2018 data indicates that in low- and middle-income countries, MDBs and DFIs reported over $69 billion in total private mobilization, a 4 per cent increase in total private mobilization for low-income countries over 2017.b a OECD, “Amounts mobilized from the private sector by official development finance interventions in 2017-2018” (January 2020). b MDB Task Force on Mobilization, “Mobilization of private finance by MDBs and DFIs 2018” (August 2019).

Development finance institutions have tools to help investors and banks platform launched in 2020 by a coalition of private and public sector achieve volume while reducing transaction costs. For instance, MDBs have organizations, including United Nations entities, which will use debt and operated syndicated-loan programmes for decades, which allow financiers, equity to bridge the financing gap of businesses in emerging and frontier such as international banks, to participate in MDB loans and benefit from markets. The platform comprises six funds; each of them will include a the preferred creditor advantage of MDBs. More recently, the IFC has catalytic first-loss layer. created the Managed Co-Lending Portfolio Program (MCPP) that serves as a syndication platform and creates diversified portfolios of emerging 4.5 Securitization market private sector loans. As of 2018, the MCPP has raised $7 billion from eight global investors. The MCPP Infrastructure facility—which offers Securitization is another way of bundling deals. In these structures, a bank one solution to channel more funding into emerging market infrastruc- sells a portfolio of loans to investors by issuing a security. In essence, the ture while demonstrating a path for other investors to follow—allows bank is selling part of its balance sheet of loans to investors. This allows investors to gain exposure in these markets by co-lending to a portfolio the issuing banks to free up space on its balance sheet, increasing their of companies alongside the IFC on commercial terms, while their risk is lending capacity. Such bundling makes use of diversification by combining mitigated through a first loss tranche.50 SDG500 is another investment different assets with idiosyncratic risks. Typically, securitized assets are

69 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

also structured in tranches with different risk-reward characteristics to have large diversified SME lending, which could benefit from securitization appeal to a diverse range of investors. to expand their lending capacity. In contrast, securitization is of little use Securitization has been a tool to increase lending in the housing market in to banks with ample liquidity. A wider application of such financial engi- the United States since the early 1980s. In 2019, the market reached about neering in developing countries, including risks, warrants more research. $1 trillion, including auto loans, student loans, and SME loans. China is the second largest securitization market with the total value of issuance 4.6 Insurance and risk guarantees 51 at about $300 billion in 2019. MDBs have also entered this field. In 2018, Investors might be reluctant to invest if certain risks are deemed too high 52 the African Development Bank used synthetic securitization to transfer and cannot be properly managed. Insurance and guarantees can provide a the credit risks of a portfolio of $1 billion loans on its balance sheet to a solution by enabling the transfer of risk to entities that are better equipped 53 group of investors (see chapter III.C). to hold that risk, such as foreign investors or institutions holding diversi- Nonetheless, securitization is not without risk as demonstrated by the fied portfolios (for example, across several countries or currencies)—any 2008 financial crisis. For example, for securitization of many small SME one loss would be compensated by returns on other investments. The loans to be successful, there should be ample diversification. In the lead up following examples illustrate the benefits of diversification at an interna- to the global financial crisis, many sub-prime mortgage-backed securities tional level and suggest avenues to further develop instruments: were issued with highly correlated loans, so that in an event of a downturn Political risks insurance. Political risk insurance has long existed to it was likely that most homeowners would default at the same time (which protect private investors from expropriation risks, breach of contract is what happened). Banks also lowered their lending standards, and in or currency transfer restrictions. Export credit agencies and develop- some cases, banks sold off their worst performing loans (since investors ment institutions, such as MIGA, which are large providers of political had more limited information). risk insurance, can better manage these risks than individual investors Securitizations can be structured to overcome some of these risks, but since they have a diversified portfolio of political risk across countries. countries need regulatory and supervisory capacity to issue such instru- MIGA and other public insurance providers may also be in a better ments effectively. For example, to ensure banks carry out proper diligence position to resolve potential disputes than private providers, given in originating loans, they should keep “skin in the game” (i.e., they need to their relationship with local governments. Demand for political risk keep a percentage of the loans on their books). insurance is strong. MIGA’s gross exposure almost tripled between The country context also matters. Securitization is easier when capital mar- 2009 and 2018. To boost MIGA’s capacity, the use of private reinsurance, kets are developed. It also looks more promising in countries where banks in which MIGA sells part of its portfolio to a private insurer, could be

Figure III.B.8 Annual uctuation vis-à-vis US dollar of individual currencies versus a portfolio of currencies (Percentage)

80%

60%

40%

20%

0% 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

-20%

-40%

-60%

-80%

-100%

-120% Bottom 10% Bottom 25% Top 10% Top 25% Portfolio uctuation (average) Minimum Maximum

Source: Currency Exchange Fund (TCX).

70 DOMESTIC AND INTERNATIONAL PRIVATE BUSINESS AND FINANCE

expanded so MIGA could recycle its capital for more projects. Standard- However, the low uptake and the need for scale raise questions as to izing contracts and processes could facilitate the sale of political risk at whether this is the optimal approach, and whether public authorities a portfolio level instead of a project-by-project level. Indeed, it is much should provide protection to targeted groups (e.g., farmers). In addi- more complex to pool contracts with different terms and conditions.54 tion, there is also a risk that with greater digitalization and forecasting Another solution to increasing MIGA’s capacity is to allocate concession- precision, regions and sectors most at risk will be priced out of insur- al resources to support MIGA in advancing risk insurance in countries ance markets, and only those with low or moderate risk will be able to where it has reached exposure limits,55 but such use of concessional find coverage. International cooperation and public intervention may resources needs to be weighed against other uses; be necessary to make sure these regions and sectors are not excluded Currency hedging instruments. When companies with domestic from the insurance market and can attract investment (see chapters II revenues borrow in dollars or other external currencies, they are and III.C). Alone, disaster risk insurance is not sufficient to counter the subject to currency risk (i.e., they are exposed to losses if the local full loss due to disasters. To be effective, disaster risk insurance must currency devaluates). This situation typically arises in markets where incentivize disaster risk reducing behaviour in the private sector and local currency financing is not affordable or available at required include provisions to ensure companies build better from the start and volume and maturities, and where hedging instruments do not exist build back better after a disaster. Moreover, disaster risk insurance or are prohibitively expensive. In the medium term, the solution is to must be part of a larger disaster risk reduction financing strategy (see develop liquid capital markets. In the near term, a broader array of risk chapters III.A and III.C). management tools can be used. In particular, diversification across a basket of currencies considerably reduces volatility on a portfolio level (figure III.B.8) and has proven to be a powerful tool for currency risk 5. Sustainable corporate practices and management. There are several mechanisms funded by donors based on this principle, including the currency exchange fund (TCX) and the financial systems Local Currency Facility (LCF). As multilateral development banks lend Unlocking private business and investment is a necessary condition for across countries, it could be possible for them to increase lending in achieving sustainable development, but unless private business practices local currencies by managing local currency risk through diversification, become more sustainable, progress towards the global goals will fall short. or by offloading the currency risk to a reinsurance/international vehicle. There are several reasons why business leaders can no longer ignore This was noted in the Addis Agenda, in which Member States of the sustainability issues: United Nations “encourage development banks to make use of all risk management tools, including through diversification”; Operational risk. Sustainability issues can affect companies’ operation. For example, frequent and more severe climate hazards alter firms’ Disaster risk insurance. Natural hazards pose another risk to invest- productivity, disrupt supply chains and destroy infrastructure. Similarly, ment. An important instrument for managing this risk is through water is fundamental to many businesses (e.g., to cool or clean or as an insurance, which mutualizes it across locations and types of events, ingredient) and shortages can severely impact business operation; again making use of diversification for risk management. Insurers can lay off some of this risk through capital market instruments (i.e., Changing regulatory environment. Companies anticipate future catastrophe bonds), thus freeing up capital for additional underwrit- policy changes that will discourage unsustainable practices—for ing. Nonetheless, disaster risk insurance faces challenges, as both risks instance, through pricing carbon emissions or putting a higher price and losses are often difficult to evaluate, especially as climate change tag on waste production; is altering the frequency, variability and impact of weather-related Market opportunities. Companies not embracing sustainability disasters. Disaster risk insurance never fully covers the losses from might miss business opportunities linked to the SDGs (e.g., affordable disasters. Of particular concern, frequent losses from small-scale and housing) or changing consumer demand. For example, since 2013 localized disasters do not cross certain parameters while they erode sustainability marketed products have grown 5.6 times faster than the capital assets and resilience of businesses and communities. Digi- conventional products in the US consumer-packaged goods market.57 talization and the growing availability of data is helping insurers better Digitalization could also make information about products and suppli- understand and price disaster risk, which has led to insurance products ers more accessible to citizens, giving them the tools to consider SDG being offered in areas that were not covered before. In addition, index impacts in their purchasing decisions;58 insurance products, which provide a pre-agreed sum in case specified Reputational risk. Sustainability scandals, which can be inflated by parameters are met, such as a drought, can be cheaper to operate as social media, could hurt a brand’s reputation and performance in some there is no need to estimate the actual loss. For example, these can sectors (e.g., consumer products). Technology advancement is also be used to protect small-scale farmers against losses from extreme making information about corporate practices more accessible and weather. However, setting the parameters correctly remains chal- transparent (see box III.B.4). lenging. There are cases where companies that buy insurance are not covered during a catastrophic event because certain triggers are not Individual investors and financiers also realize that the performance of activated. In addition, the products can be expensive and not well un- the companies they finance depends in part on how these companies deal derstood by consumers. As a result, their uptake has been slow, despite with sustainability issues. More individual investors are expressing interest substantial public support.56 Regulators can try to build trust through in sustainable investing practices (from 71 per cent in 2015 to 85 per 59 consumer protection and information regarding insurance coverage. cent in 2019, in one survey). Financiers are increasingly divesting from 71 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

companies that are at odds with some of the SDGs. For example, a group of ESG-related performance goals, such as GHG emission targets, in their institutional investors representing nearly $4 trillion of assets under man- executives’ pay.68 This should be further promoted, for instance, by agement—the UN-convened Net-Zero Asset Owner Alliance, committed to sustainability-oriented investors or shareholders of state-owned entities transitioning their investment portfolios to net-zero greenhouse gas (GHG) who could request companies they invest in to lead the way. emissions by 2050. In the banking sector, 130 banks from 49 countries have committed, through the Principles for Responsible Banking launched in 5.2 Raising policy ambitions 2019, to work with their clients to encourage sustainable practices. Public policies are key to providing incentives for companies to align their Yet, the private sector transformation is not happening fast enough nor businesses with sustainable development objectives. There are already at the required scale. Such a transformation will require (i) rethinking some positive developments: for instance, the number of carbon-pricing corporate governance; (ii) raising public policy ambitions; and (iii) making initiatives continues to increase, now covering about 20 per cent of GHG financial system a force for change. emissions. However, in most cases, the price levels remain too low to change behaviour (less than 5 per cent of the global emissions are priced 5.1 Rethinking corporate governance at a level compatible with the goals of the Paris Agreement) and there Some business leaders have started to rethink their fundamental approach has been public pushback against certain initiatives, such as increases 69 to business. In 2019, CEOs of almost 200 firms, representing nearly 30 per in gas prices. A carbon price would create a level playing field so that cent of US market capitalization, redefined the purpose of a corporation companies that do take carbon goals into account would not be penal- away from a sole focus on shareholders to include all stakeholders—cus- ized with lower financial returns in the short run. It would also provide tomers, employees, suppliers, communities and shareholders—based incentives to adopt and develop low carbon technologies without being on the idea that each stakeholder is essential to a company’s long-term prescriptive about particular technologies. In 2019, at COP25 in Madrid, success.60 Many companies have also joined initiatives to improve the sus- 631 investors managing over $37 trillion called on Governments to put 70 tainability of their industry (e.g., the Fashion Industry Charter for Climate a meaningful price on carbon. In cases where carbon prices might be Action launched in 2018 and the Getting to Zero Coalition in the maritime politically difficult, policymakers should consider offsetting instruments shipping sector launched in 2019). (e.g., distributing part of the revenues). At the same time, carbon pricing should be complemented by additional measures. These are important developments, but they alone are unlikely to alter corporate behaviour sufficiently, particularly in the absence of proper Policymakers can use regulation—such as labour standards, minimum accountability mechanisms and change in corporate governance (and wages, disaster risk reduction and environmental norms—to incentivize internal incentives). To give teeth to the shift in focus from “shareholder companies’ alignment with the SDGs. For example, legislation to regulate to stakeholder”, corporate boards should issue a statement of purpose the use of plastic bags (put into place by 127 countries since the early 2000s) that recognize their different stakeholders, and put mechanisms in place have triggered a rethinking in the packaging industry and a more circular 71 to oversee the implementation of this statement of purpose.61 This is economy. Similarly, government leadership is needed to ensure, for similar to the model followed by Certified B Corporations which have instance, that human rights are upheld in the context of business activi- been adopted by about 3,000 companies in 64 countries.62 Media and ties, including by passing and enforcing legislation to protect workers and non-governmental organizations (NGOs) have a critical role to play in affected communities. However, the Corporate Human Rights Benchmark, monitoring and ensuring that industry commitments deliver results. which assesses 200 of the largest publicly traded companies, underlines that the current level of compliance is distressing, as more than half of the Sustainability issues should be discussed at the board level and be part benchmarked companies score less than 20 per cent on a set of human rights 63 of Director duties. Yet, only 22 per cent of executives believe that indicators.72 their own boards properly oversee these issues.64 The need to require corporate boards to develop and disclose a sustainability strategy, includ- Overall, the level of policy ambition will determine the private sector’s re- ing measurable targets, is currently being assessed in the European Union sponse. Companies may not modify their practices if they are not convinced (EU).65 The Financial Stability Board’s Task Force on Climate-related Fi- that Governments will take the required actions to achieve the global goals. nancial Disclosures (TCFD) already recommends the disclosure of the board oversight and management role in relation to climate-related financial 5.3 Making financial systems a force for change risks and opportunities. Active shareholders have also put pressure on Financial systems can accelerate the private sector transformation towards management to consider ESG issues by filing proposals for the annual gen- more sustainability if they are long-term oriented. To date, investors have eral meeting and through proxy votes. For example, the median support primarily been interested in sustainability issues for their impact on finan- for environmental and social shareholder proposals increased from 6 to 30 cial returns. However, those who want their money to also do good in the 66 per cent between 2000 and 2019. However, the United States Securities world, also need to know the answer to this question: what is the impact of and Exchange Commission (SEC) revision on the rules on shareholder pro- investing on the SDGs? posals (e.g., by significantly increasing the portion of the vote a proposal must receive to be resubmitted in subsequent years) could have the effect 5.3.1 Sustainable development investing definition of making this more difficult.67 There are a wide range of investment strategies used by portfolio manag- Corporate incentives should also be adjusted. For example, an esti- ers, with different impacts and levels of sustainability, under the heading mated 71 of the 3,000 largest US-traded stocks include some form of of “sustainable investments”. This creates confusion. 72 DOMESTIC AND INTERNATIONAL PRIVATE BUSINESS AND FINANCE

A common defi nition of Sustainable Development Investing (SDI) could (i) Principles and guidance to reinforce investment practices. For example, help establish norms that diff erentiate investment strategies and defi ne the Operating Principles for Impact Management, launched in 2019, minimum thresholds that investment strategies and products should meet have been created to establish a common discipline to ensure that to qualify as SDG-aligned. impact considerations are integrated throughout the investment 74 Without a common understanding, there is a risk that fi nancial products lifecycle. More than 80 international investors have signed on to and strategies are presented as sustainable without making a meaningful these principles. Signatories to these principles commit to annual contribution to the achievement of the Goals (i.e., so-called green- and disclosure of how they implement them, and independent verifi ca- SDG-washing). For example, some “sustainable” funds include tobacco tion of their impact management processes. Meanwhile, the United or fossil-fuel companies, based on their relatively good ESG performance Nations Development Programme has created assurance standards to compared to industry peers, while their impact on sustainable develop- guide investors in operationalizing existing principles in this area— 75 ment is at least questionable. A set of common norms could counter the for instance for private equity practice —and the United Nations risk of SDG washing and misleading investment products that use sustain- Environment Programme Finance Initiative’s (UNEP FI’s) Positive able development as a marketing tool. Impact Initiative has provided principles and tools to mainstream impact analysis and management in fi nance.76 The Impact Manage- For example, the CEO-led Global Investors for Sustainable Development ment project has also created a framework to look at impact around Alliance, convened by the United Nations Secretary-General, has been fi ve dimensions;77 working on developing such a defi nition, building on the spectrum of existing investment strategies while respecting existing defi nitions of (ii) Technical criteria defi ning what is “sustainable”. For example, stan- impact investing (fi gure III.B.9). dards have been created for green and sustainable-oriented bonds to defi ne the eligible assets (use of proceeds) that can be fi nanced by Figure III.B.9 shows a range of investment strategies that go beyond impact these instruments, although further harmonization among diff erent investing, which has “doing good” as an explicit investment objective, frameworks would be welcomed. The ASEAN Green Bond Standards, and includes strategies focused on fi nancial return maximization that for example, explicitly exclude all power generation projects based still align portfolios with the SDGs. It separates strategies likely to create on fossil fuels, while China includes clean coal, for now, as a green positive change from those that are designed only to do no harm (e.g., category. Being able to assess the contribution of private companies is negative screening) or mitigate investor risks (e.g., ESG integration and an important precondition to sustainable development equity invest- engagement). ing, which is discussed in the next section. Once developed, investors could align their investment with a defi nition and take actions to increase their portfolio allocation to sustainable devel- 5�3�2 Corporate contribution to the Sustainable Development Goals opment. This could create a strong signal to the market.73 Companies aff ect sustainability in two ways: through the products and To implement such a defi nition, investors would benefi t from services they produce, and through their operational activities. In terms of

Figure III.B.11 Sustainable Development Investing (SDI)

Sustainable Development Investing

Impact Investing SRI / ESG investment strategies Traditional Philanthropy Positive or Sustainability ESG integration Negative investing Concessional Market rate Best-in-Class themed screening & engagement Screening

Address Invest with the intention to Invest in Selecting best Integrate ESG Exclude Invest to Key features societal generate positive,measurable themes or performing factors into activities or maximize challenges by social and environment impact assets companies investment industries nancial donating alongside a nancial return constructed across decisions to with clearly returns private money around the industries in better manage de ned regardless of to good causes SDGs (e.g., terms of risk and negative ESG factors water and sustainability possibly impacts from gender) performance enhance an investment nancial portfolio (e.g. returns arms)

Social return & Social return & Social return Financial market Return expectation sub-market market nancial Financial market rate focused only rate only nancial return return

Impact Investment likely to create positive sustainable development outcomes do no harm

Source: UN DESA and Global Investors for Sustainable Development based on RIAA (Responsible Investment Association of Australasia) Note: SRI stands for Sustainable and Responsible Investing. While ESG engagement plays a key supportive role to SDI, engagement is not su cient to meet the denition.

73 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

production, different taxonomies have emerged to help classify company Data availability is critical, including, for instance, information on the activities.78 For example, the EU reached an agreement in 2019 about a distribution of revenues, jobs and/or investments per business lines and classification system, or “taxonomy,” that helps businesses and investors country. Investors can also use technology to look at unreported data, identity what economic activities can be considered environmentally such as from social media and news outlets, and check whether a specific sustainable.79 These taxonomies provide technical screening criteria that company might be involved in certain controversies incompatible with must be fulfilled in different sectors. A minimum set of criteria is important sustainable development (box III.B.4). to keep firms from claiming “SDG alignment” because they are broadly present in sectors covered by the SDGs (e.g., health care, education). 5 .3.3 Sustainability reporting Fundamental analysis at the company level is therefore critical to analyse Enhancing corporate disclosure is key to reinforcing accountability frame- the real impact of individual companies on the SDGs. In this respect, the works. Policymakers and consumers cannot hold companies accountable World Benchmarking Alliance (WBA) plans to rank 2,000 companies, without proper information both on social and environmental issues. estimated to be the most influential ones, regarding their impact on the Investors need information to make risk-return analyses (e.g., a company’s SDGs and will make the results freely and publicly available. Assessing the exposure to climate change). Financial reporting standards have allowed contribution of a private company to sustainable development also neces- companies to speak the same language in measuring financial perfor- sitates an understanding of where companies operate and who they serve, mance. There is a need for similar frameworks and common metrics for in particular whether they target countries and people most in need. This environmental and social impact disclosure. is what some methodologies, such as UNEP FI’s Holistic Impact Analysis As of now, corporate sustainability reports are difficult to compare and the Tools are starting to do. hundreds of ESG data points per company are overwhelming, sometimes An analysis of the MSCI World Index found that 11 and 20 per cent of meaningless, and often behind paywalls. The quality of sustainability companies in this index (about 1,700 stocks from 23 countries) have, reporting also needs improvement. A recent study of more than 700 mul- respectively, a high and medium positive contribution to the SDGs.80 tinational companies found 72 per cent of published sustainability reports In terms of operations, ESG metrics focus on measuring how a company mentioned the SDGs, but just 23 per cent included meaningful key perfor- produces (versus the products and services that the company produces). mance indicators (KPI) and targets.81 While at least 24 stock exchanges across developed and developing countries are now requiring ESG disclo- Figure III.B.10 provides a framework to assess whether a company’s sure as a listing rule,82 globally, ESG disclosure for listed companies has products/services and operations are aligned with sustainable develop- not significantly improved since 2013.83 Without numbers, sustainability ment objectives.

Figure III.B.10 Framework to assess the impact of (listed) companies on the SDGs

Impact of private Products and Services companies on Operations the SDGs

Examples: • Sustainable agriculture • Weapons • Sustainable production • Pollution • Medical equipment • Gambling • Inclusive workforce • Waste generation • Water infrastructure • Tobacco • Gender balance • Human rights violations • Renewable energy • Coal power plants • Health and safety • Bribery • Public transportation • Fast food • A ordable housing • Deforestation

Examples of possible metrics • Number of metric tons of CO2 emissions avoided • Environmental area: % of raw materials from sustainable sources, • % of company revenue associated with positive products and % of recycled materials, % of water recycled, GHG emissions, services green building policy • Geographic revenue breakdown • Social area: % of women in management, number of jobs created • % of revenue from products serving low income groups / quality of jobs, employee wages and benets as proportion of • Industry specic: Number of people with access to nancial revenue, frequency of occupational injuries services in underserved segment of the population (output for • Taxes and other payment to the Government the nancial industry)

Source: UN DESA based on MSCI/OECD joint discussion paper on institutional investing for the SDGs (December 2018). 74 DOMESTIC AND INTERNATIONAL PRIVATE BUSINESS AND FINANCE

Box III.B.4 Leveraging technology to assess the SDG footprint of the private sector There are two main challenges with using self-reported data by compa- Figure III.B.4.1 nies. First, data might be biased since company are likely to report only SDG footprint score, global average on positive elements. Second, data are updated infrequently (typically (Score -1 (min) to +1 (max))

once a year). This makes them less relevant for investors who need to 0.25 react quickly to emerging negative sustainability issues. Artificial Intelligence (AI) and natural language processing help address these challenges by analysing and interpreting unstructured data from 0.2 thousands of sources, in multiple languages, such as news, social media,

regulatory filings, government reports, blogs, industry-specific publica- 0.15 tions, and NGO websites. To analyse these data, an algorithm uses a sustainable development goals (SDGs) taxonomy to identify relevant SDG-related information across large amounts of unstructured content. 0.1 The algorithms can then extract, filter, and analyse text and syntax structure to detect positive and negative signals on SDG issues. 0.05 The resulting time series data can then be transformed into SDG scores. The higher the score, the more positive the text is in relationship to each SDG. For example, for SDG 5 (on gender equality), an algorithm 0 would give a better score to a company that doubles the number of 2015 2016 2017 2018 2019 women on their board of directors than a company that announces the hiring of two female analysts. Figure III.B.4.1 illustrates how AI can be Source: Global A.I. Corporation used to monitor the SDG footprint of private companies over time, and Note: The SDG footprint incorporates data from 19,819 companies across Africa, Asia, Europe, shows a relative improvement in the way corporates are integrating SDG Oceania and the Americas. considerations. reporting quickly becomes a public relations exercise. Making the sustain- companies rank the highest in terms of environmental, social and gover- able impact of companies more transparent and readable should help nance performance. inform investor, consumer and regulator decision-making. Financial materiality has so far been the compass for deciding what The Financial Stability Board’s Task Force on Climate-related Financial companies should be disclosing (i.e., a company needs to disclose events Disclosures (TCFD) recommends companies disclose the impacts of or facts that could impact its financial performance and would affect the climate-related risks on their business, taking into consideration different judgment of investors). However, if corporates are accountable not just climate-related scenarios. As of February 2020, support for the TCFD has to investors but to a broader audience, this compass also needs to cover grown to over more than 1,000 organizations, representing a market information required to understand the impact of companies’ activity on capitalization of nearly $12 trillion. Yet, the implementation of TCFD issues that matter to the whole society, such as the global goals. recommendations remains partial. Only about 25 per cent of companies The largely voluntary nature of sustainability reporting is also problematic. disclosed information aligned with more than 5 of the 11 recommended While standards from the Global Reporting Initiative (GRI) are widely 84 disclosures (based on a review of 1,100 companies from 142 countries). used,87 companies can still choose to report only on positive results Similar to climate risks, other sustainability issues can be financially mate- and avoid communicating on negative impacts. The time has come to rial. The Sustainability Accounting Standards Board (SASB) has identified shift from voluntary to mandatory sustainability reporting, building which sustainability issues are likely to impact the financial condition on industry-led efforts and reporting standards which provide a better 85 or operating performance of a company by industry. Investors use understanding of how such reporting can be efficiently done. Mandatory this information to guide their decisions. As an example, Blackrock, the reporting also helps create a level playing field for all. world’s largest asset manager is asking the companies that they invest in to publish a disclosure in line with industry-specific SASB guidelines and To ensure a minimal level of disclosure, as well as consistency around disclose climate-related risks in line with TCFD recommendations.86 As metrics used for corporate reporting on SDG impact, policymakers could more investors follow Blackrock’s lead, corporates will need to be more include in reporting requirements a list of criteria, possibly per industry. To transparent on sustainability questions to attract capital. this end, they could, for instance, use the guidance issued by UNCTAD on core indicators for entity reporting on contribution towards the implemen- Increasing transparency is a powerful mechanism to trigger changes. tation of the SDGs,88 as well as the GRI standards.89 The former contains Figure III.B.11 provides evidences that what gets measured, gets managed. 33 indicators on companies economic, environmental, social and gover- Countries with the highest level of disclosure are the countries where nance performance, which are common to all businesses, such as use of

75 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Figure III.B.11 ESG disclosure vs performance 90 Germany 80 Chile Spain France 70 Netherlands UK Italy 60 R = 46% Brazil Thailand Sweden

50 Switzerland Australia Norway 40 Canada Singapore United States Belgium Denmark 30 Ireland Mexico

Median RobecoSAM ESG RankMedian RobecoSAM South Africa India Republic of Korea 20 United Arab Emirates Japan 10 China Indonesia Philippines

0 10 15 20 25 30 35 40 45 50 55 60 Median Bloomberg Disclosure Score

Source: Bloomberg intelligence. Notes: ESG disclosure score: Proprietary Bloomberg score based on the extent of a company's ESG disclosure . This score measures the amount of ESG data a company reports publicly, and does not measure the company's performance on any data point. RobecoSAM Total Sustainability Rank: Total sustainability percentile rank, converted from the total sustainability score, based on the RobecoSAM Corporate Sustainability Assessment. Country aggregate represents the median score of all the companies within the FTSE all world index domiciled in each respective country.

water, energy, generation of waste and carbon emissions, gender equality For example, Canada created an expert panel on sustainable finance and work place safety among others. Several case studies have confirmed in 2018, which outlines fifteen recommendations to mobilizing finance the applicability of these core indicators in different geographical areas, for sustainable growth.92 Central bankers are also considering how to industries and companies of different sizes.90 address financial stability risk that sustainability issues may create (see chapter III.F) 5.3.4 Sustainable finance strategies These initiatives have led to concrete results. For example, forty-eight To structure policy actions, Governments can develop a strategy to of the world’s 50 largest economies now have some form of policy to promote sustainable finance and consider designating an institution in foster investors to consider sustainability issues.93 Since there is growing charge of implementing it. This creates a momentum and support from evidence that some ESG factors are financially material,94 particularly over within a Government. For example, in 2016, public authorities in China long investment time horizons, regulation should explicitly require that issued guidelines for establishing the green financial system, which pension funds and insurance companies, known as fiduciaries, consider resulted in major progress in green financial products and standards. In these factors in their investment decisions. Regulation should also include the same vein, at least ten countries have adopted a national strategy for disclosure requirements from pension funds to explain how they incorpo- impact investing.91 In Brazil, the implementation of such a strategy is rate ESG factors into their investment policies to ensure that these issues assigned to a multi-stakeholder committee composed of several ministries, are seriously considered and that beneficiaries are properly informed. It is development and commercial banks, financial market regulators and equally important to make it mandatory for financial advisors and fiducia- representatives from civil society. This kind of platform creates a structure ries to ask their clients/beneficiaries about their sustainability preferences for stakeholder consultations that are necessary before the adoption of and empower people in their financing decisions. Technological advance- regulations or policy reforms. Governments have also established expert ment should be leveraged to strengthen communication between clients panels to come up with recommendations to scale up sustainable finance. and those who manage money on their behalf.

76 DOMESTIC AND INTERNATIONAL PRIVATE BUSINESS AND FINANCE Endnotes 1 World Bank, Global Economic Prospects: Heightened Tensions, Subdued Investment (Washington, D.C., World Bank, 2019). Investment activity refers here to real gross fixed capital formation (public and private) and outlook is based on surveys. 2 World Bank, “H1 2019 Private Participation in Infrastructure (PPI)”. 3 UNCTAD, “SDG Investment Trends Monitor” (United Nations publication, 2019). 4 See UNCTAD, “Investment Trends Monitor”, Issue 33, (January 2020). 5 UNCTAD, “Impact of the Coronavirus Outbreak on Global FDI”, Special Issue of UNCTAD’s Global Investment Trends Monitor (Geneva: UNCTAD, 8 March 2020). 6 Global Sustainable Investment Alliance, “2018 Global Sustainable Investment Review” (2018). 7 The Index Industry Association, “IIA 2019 Index Survey Snapshot”. ESG-based indexes are constructed using ESG rating. 8 Climate Bonds Initiative, “Green Bonds Reach Record $255bn for CY 2019” (16 January 2020). 9 See Global Impact Investing Network, “Impact Investing.” Available at https://thegiin.org/impact-investing/ 10 Abhilash Mudaliar and others, “2019 Annual Impact Investor Survey”, Global Impact Investing Network (June 2019) 11 World Bank, Doing Business 2020: Comparing Business Regulation in 190 Economies (Washington, D.C., World Bank, 2020). 12 World Bank, “Women, Business and the Law 2019: A Decade of Reform” (27 February 2019). 13 Jonathan David Ostry and others, “Economic Gains From Gender Inclusion: New Mechanisms, New Evidence”, IMF Staff Discussion Note, SDN/18/06, (Washington, D.C., IMF, 2018). 14 World Bank, “Growing in the Shadow: Challenges of Informality”, Global Economic Prospects (Washington, D.C., World Bank, January 2019), pp. 129-195. 15 UNCTAD, “Global Action Menu for Investment Facilitation” (United Nations publication, 2017). 16 See Better Work. Available at https://betterwork.org/ 17 IMF, World Economic Outlook: Growth Slowdown, Precarious Recovery (Washington, D.C., IMF, April 2019); and United Nations, Inter-agency Task Force on Financing for Development, Financing for Sustainable Development Report 2019 (New York, UN, 2019) 18 See for example the Coalition for Disaster Resilient Infrastructure for more information on the topic (https://resilientinfra.org/). 19 Stephane Hallegatte and others, “Lifelines: The Resilient Infrastructure Opportunity”, World Bank (2019). 20 Marianne Fay and others, “Hitting the Trillion Mark: A Look at How Much Countries Are Spending on Infrastructure”, World Bank Policy Research Working Paper 8730, (Washington, D.C., World Bank, 2019). 21 IRENA, “Renewable Power Generation Costs in 2018” (Abu Dhabi, IRENA, 2019). 22 World Bank, “H1 2019 Private Participation in Infrastructure (PPI)”. 23 See Scaling Solar. Available at https://www.scalingsolar.org/ 24 Consultative Group to Assist the Poor, “How Digital Finance Boosts Access to Basic Services”. 25 UNEP FI Positive Impact Initiative, “Rethinking impact to finance the SDGs: a position paper and call to action” (2018). 26 Marianne Fay and others, “Hitting the Trillion Mark: A Look at How Much Countries Are Spending on Infrastructure”, World Bank Policy Research Working Paper 8730, (Washington, D.C., World Bank, 2019). 27 Asli Demirgü-Kunt and others, The Global Findex Database 2017: Measuring Financial Inclusion and the Fintech Revolution (Washington, D.C., World Bank, 2018). 28 SME Finance Forum, “MSME Finance Gap” 29 OECD, Financing SMEs and Entrepreneurs 2019: An OECD Scoreboard (Paris, OECD, 2019), p. 22. 30 Miriam Bruhn and others, “MSME finance gap: assessment of the shortfalls and opportunities in financing micro, small, and medium enterprises in emerging markets” (Washington, D.C., World Bank, 2017), p.45. 31 Ibid, pp. 48-49 and IMF, “Fintech: The experience so far”, Policy Paper No. 19/024 (Washington, D.C.: IMF, 27 June 2019), p. 31. 32 Alliance for Financial Inclusion, “National financial inclusion strategies: Current state of practice” (Kuala Lumpur, AFI, June 2018). 33 Liliana Rojas-Suarez, “Branch to Root: A New ‘Decision Tree’ Tool to Improve Financial Inclusion”, Center for Global Development, (Washington D.C., Center for Global Development, October 31, 2019). 34 See the Entrepreneurship Policy Framework and Implementation Guidance developed by UNCTAD for further details. 35 UNCTAD, World Investment Report 2019: Special Economic Zones (United Nations publication, Sales No. E.19.II.D.12).

77 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

36 Ibid. 37 Ibid. 38 Ibid. 39 ESCAP, “Foreign Direct Investment and Sustainable Development in International Investment Governance”, Studies in Trade, Investment and Innovation, No. 90 (2019) Foreign Direct Investment and Sustainable Development in International Investment Governance (United Nations publication, Sales No. E.20. II.F.6, 2019). 40 For example, banks are funded by short to medium term deposits and can only take limited risks while pension funds have longer-term liabilities are able to invest in less liquid – although relatively safe – products. Private equity funds managing assets on behalf of high net worth individuals can take more risks provided expected returns are commensurate. 41 Robert Cull, Asli Demirgüç-Kunt, and Jonathan Morduch, “The Microfinance Business Model: Enduring Subsidy and Modest Profit”, The World Bank Economic Review, vol.32, No. 2 (2018), pp. 221–244. 42 In PE/VC, investors trust a fund manager to make direct investment in unlisted companies on their behalf. In addition to risk capital, PE/VC funds typically bring technical and managerial expertise to help companies grow and improve their performance. The objective is to raise the investee value to make a profit at the exit - for instance by selling the company to another industry player after a few years. 43 EMPEA, “Global Limited Partners Survey: Investors’ Views of Private Equity in Emerging Markets 2019” (Washington, D.C., EMPEA, 2019). 44 Bain & Company, “Global Private Equity Report 2019” (2019). 45 EMPEA, “Industry Statistics Year-End 2018: Emerging Markets Private Capital Fundraising and Investment” (Washington, D.C., EMPEA, 2019). 46 For example, see more information on so-called DFI Collaboration Pilots at https://www.dfifragilityforum.org. 47 See for more info: John Thompson, Kris Boschmans and Lora Pissareva, “Alternative Financing Instruments for SMEs and Entrepreneurs: The case of capital market finance”, OECD SME and Entrepreneurship Papers No. 10 (2018) 48 Paddy Carter and Mark Plant, “The Subsidy Sorting Hat”, Center for Global Development Note (February 2020) 49 OECD, “Amounts Mobilised from the Private Sector by Development Finance Interventions: Highlights from 2017” (June 2019). 50 Structured funds have different tranches; the most junior tranche assumes more risk and supports the fund first losses. This improves the risk profile of senior tranches and make them attractive to more risk averse investors. 51 Tom Schopflocher and others, “Global Structured Finance 2019 Securitization Energized With $1T In Volume”, S&P Global (7 January 2019). 52 In contrast to securitization, synthetic securitization is relatively less complex and only transfers the credit risks of a loan portfolio to another investor without the ownership (i.e., the loans remain on the balance sheet of the originating bank). 53 Chris Humphrey, “African Development Bank’s landmark deal opens door to scaling up multilateral lending” (London, ODI, October 5, 2018). 54 See the proposals from the G20 Eminent Person Group on Global Financial Governance for more details: Global Financial Governance, “Making the Global Financial System Work for All: Report of the G20 Eminent Persons Group on Global Financial Governance” (October 2018). 55 MIGA has used over $100 million of concessional resources from the IDA Private Sector Window (as of April 2019) in the form of shared first loss to lower its own risk. 56 There have been approximately 150 donor-supported weather index insurance pilots alone but there have not been many pilots maturing into sustainable programmes. World Bank, “What Can Index Insurance Offer to Development?” (10 November 2016). 57 NYU, “NYU Stern Center for Sustainable Business and IRI Launch New Sustainable Market Share Index™” (11 March 2019). 58 Task Force on Digital Financing of the Sustainable Development, “Harnessing Digitalization in Financing of the Sustainable Development Goals” (Sep- tember 2019) 59 Morgan Stanley, “Sustainable Signals: Individual Investor Interest Driven by Impact, Conviction and Choice” (2019). 60 Business Roundtable, “Business Roundtable Redefines the Purpose of a Corporation to Promote ‘An Economy That Serves All Americans’” (19 August 2019). 61 Robert G. Eccles, “Statement of Purpose Guidance Document”, Hermes EOS (August 2019). 62 See for more information: B Lab. Available at https://bcorporation.net/. 63 For example, through UNDRR’s Private Sector Alliance for Disaster-resilient Societies (ARISE), over 250 companies in 25 countries have integrated disaster risk reduction and resilience into their business models to guide corporate behavior. 64 MIT Sloan in collaboration with Boston Consulting Group and UN Global Compact, “Joining Forces: Collaboration and Leadership for Sustainability”, Management Review (2015). 65 European Commission, “Commission action plan on financing sustainable growth” (2018).

78 DOMESTIC AND INTERNATIONAL PRIVATE BUSINESS AND FINANCE

66 Kosmas Papadopoulos, “Early Review of 2019 US Proxy Season Vote Results”, ISS Analytics, (June 2019) 67 Fiona Reynolds, “The SEC is trying to roll back ESG voting rights”, FT Adviser (December 2019) 68 Gillian Tett, Patrick Temple-West and Billy Nauman “Green bonds hit $1tn amid growing pains”, Financial Times (23 October 2019). 69 World Bank, State and Trends of Carbon Pricing 2019 (Washington, D.C., World Bank, June 2019). 70 The Investor Agenda, “Global Investor Statement to Governments on Climate Change”. 71 UNEP, “Legal Limits on Single-Use Plastics and Microplastics: A Global Review of National Laws and Regulations”. 72 UNEP, “Legal Limits on Single-Use Plastics and Microplastics: A Global Review of National Laws and Regulations”. 73 Impact Management Project, “Investor contribution in public and private markets” (January 2019). 74 IFC, “Operating Principles for Impact Management” (2019). 75 SDG Impact, “UNDP SDG Impact Practice Assurance Standards for Private Equity”, UNDP (2018). 76 See UNEPFI, “The Principles for Positive Impact Finance”. Available at https://www.unepfi.org/wordpress/wp-content/uploads/2017/01/ POSITIVE-IMPACT-PRINCIPLES-AW-WEB.pdf 77 Impact Management Project, “The Impact Classes of Investment”. Available at https://impactmanagementproject.com/investor-impact-matrix/ 78 Climate Bonds Initiative, “Climate Bonds Initiative Taxonomy: Information & communications technology”(October 2009). Available at https://www. climatebonds.net/files/files/CBI_Taxonomy_Tables-Nov19.pdf 79 Council of the EU, “Sustainable finance: EU reaches political agreement on a unified EU classification system”, press release (18 December 2019). Available at https://www.consilium.europa.eu/en/press/press-releases/2019/12/18/ sustainable-finance-eu-reaches-political-agreement-on-a-unified-eu-classification-system/ 80 Jacob Messina, “RobecoSAM SDG Impact Framework Bridging impact investing to mainstream investors”, RebecoSAM (September 2019). 81 PwC, “From promise to reality: Does business really care about the SDGs? And what needs to happen to turn words into action” (2018). 82 See Sustainable Stock Exchanges Initiative Database. Available at https://sseinitiative.org/data/. 83 Corporate Knights and Aviva, “2019 report on measuring sustainability disclosure – ranking the world’s stock exchanges” (January 2020). 84 Task Force on Climate-related Financial Disclosures, “2019 Status Report” (June 2019). 85 Sustainability Accounting Standards Board, “Why is Financial Materiality important?”. 86 Larry Fink, “Letter to CEOs: A Fundamental Reshaping of Finance”, BlackRock (2020). 87 A review of 159 companies shows that the clear majority (87%) of company reports reference the GRI standards. See: WBCSD, “Reporting Matters” (2019). 88 Guidance on core indicators for entity reporting on contribution towards implementation of the Sustainable Development Goals (United Nations publication, Sales No. E.19.II.D.11). 89 GRI together with UN Global Compact has developed tools to guide business to integrate the SDGs within corporate reporting which enables business to assess their impact on the SDGs (GRI and UNGC, “Analysis of Goals and Targets” (2016) and “Integrating the SDGs into Corporate Reporting: A Practical guide” (2017). 90 Main findings of these case studies were presented and discussed at the 36th session of the UN Intergovernmental Working Group on International Standards of Accounting and Reporting (ISAR) held in Geneva from October 30 to November 1, 2019. 91 OECD, Social Impact Investment 2019: The Impact Imperative for Sustainable Development (Paris, OECD, 2019). 92 Tiff Macklem and others, Final Report of the Expert Panel on Sustainable Finance - Mobilizing Finance for Sustainable Growth, Government of Canada (2019). 93 Fiduciary Duty in the 21st Century, “2019 Fiduciary Duty in the 21st Century Final Report” (2019). 94 See the list of ESG and return studies compiled by UN DESA. Available at https://developmentfinance.un.org/.

79 Infographic Goes Here INTERNATIONAL DEVELOPMENT COOPERATION DEVELOPMENT INTERNATIONAL Chapter III.C International development cooperation 1. Key messages and recommendations

The 2030 Agenda for Sustainable Development will place sig- from responses to disasters and other hazards indicate the nificant demands on public budgets and capacities that require need for ex ante financing instruments, which are efficient, scaled-up and more effective international support, including predictable and quick-dispensing and build incentives for risk both concessional and non-concessional financing. Yet, in 2018, reduction into their design. This includes an increased focus official development assistance (ODA) declined by 4.3 per cent on investing in disaster risk reduction, including epidemic and remains well below the 0.7 per cent commitment in the and pandemic prevention and preparedness. Addis Agenda. The decline was due in large part to a decrease in This chapter also explores a range of public finance instruments financing for refugees in donor countries; however, gross ODA to raise resources for the Sustainable Development Goals (SDGs) to least developed countries (LDCs) also fell by 2.2 per cent in in the context of international development cooperation, build- real terms. The Inter-agency Task Force on Financing for De- ing on the financial instruments laid out in chapter III.B. Such velopment calls on ODA providers to reverse the decline in ODA, public finance instruments are not panaceas to fill the invest- particularly to LDCs, and strongly reiterates previous calls for ment gap, but can be useful tools to make aid more effective ODA providers to step up their efforts to meet commitments and leverage other types of finance when appropriate. made in the Addis Ababa Action Agenda. Blended finance is one instrument that has received significant South-South cooperation (SSC) continues to expand in scope, attention. While blended finance has grown rapidly, the evi- volume and geographical reach. As the role of SSC and trian- dence on its development impact is less robust. Most blended gular cooperation deepens, documenting its added value and finance currently goes to middle-income countries, motivated impact on sustainable development by relevant stakeholders by the size and ease of transactions, with only a small portion could further support implementation of the Sustainable going to LDCs, in part because blended finance is not appropri- Development Goals. ate for all investments or activities. To increase effectiveness, The Addis Agenda also recognizes the important role of devel- concessional resources should be allocated where the need and opment banks in implementation of the 2030 Agenda. In 2019, impact are greatest. Blended finance needs to switch from several multilateral development banks (MDBs) completed a search for bankability to a search for impact, based on successful capital replenishments. In addition, some MDBs have country needs and ownership, with judicious use of blending taken steps to raise additional resources through innovative in circumstances where it is determined to be the best suited mechanisms. Other development financial institutions (DFIs) tool. Capacity development support towards these efforts can can learn from innovative efforts to raise additional resources, help countries identify and apply appropriate instruments. including risks that need to be managed. MDBs have also In the next 10 years, many developing countries are expected increased efforts to align activities with the Addis and 2030 to transition to higher income per capita status. Higher incomes Agendas. These activities should be continued and stepped can be translated into tangible SDGs progress. Nonetheless, this up to fully align activities to the 2030 Agenda, including positive news comes with challenges, especially for graduates harmonizing gender-equality monitoring indicators. that are highly vulnerable to climatic events and other disasters, The recent spread of the coronavirus has also raised questions as graduating countries may lose access to concessional finance on whether available resources are sufficient to help countries windows. In response, ODA providers are including greater prevent and respond to epidemics and pandemics. Experience flexibilities for these types of vulnerabilities and for conflict/ 81 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

political instability. However, there are areas for improvement for all administrative costs), increased slightly, by 0.3 per cent. However, in LDCs, graduation contexts (LDC graduation, graduation from multilateral LLDCs and African countries, CPA fell by 1.1, 7.2 and 0.1 per cent, respec- concessional windows, ODA graduation, etc.), including emphasis tively (figure III.C.3). on pre-graduation planning (including addressing simultaneous The allocation of ODA should align with country priorities and plans (see graduations); capacity development focused on areas where financing section 4). The slight increase in CPA in 2018 was led by higher disburse- constraints may be greatest (e.g., for domestic resource mobilization ments in the social sector versus a decline in production sectors (figure and debt management); and strengthening exceptional and temporary III.C.3). In particular, CPA to the education subsector increased for all support measures for countries in transition, including having a process country groups. for reverse graduation. Efforts to increase and improve access to ODA, as well as to mobilize ad- ODA concessionality ditional resources for development, must be matched by efforts to improve Grants make up the majority of bilateral ODA to developing countries the quality, impact and effectiveness of development cooperation. Coun- (83 per cent ), followed by concessional loans (16 per cent) and equity tries should aim to better link their plans, strategies and resources, while investment (1 per cent) (figure III.C.4). This composition has been relatively development partners should make more effort to align their interven- unchanged since 2015, although there have been some changes to the tions to country priorities. Integrated national financing frameworks sectoral allocation (figure III.C.5). Since 2015, there has been a slight fall (INFFs) can be a useful tool to improve the effectiveness of development in grant financing to the social sectors, though these are still more than 90 cooperation by matching plans, strategies and resources. per cent grant financed, with production sectors being about 80 per cent This chapter starts by examining trends in international development grant financed. There is less grant financing channelled into the economic cooperation. As requested in the 2019 ECOSOC Financing for Development sectors, which are more often able to generate their own revenue streams Forum outcome document, the chapter then takes a more in-depth look and are almost two thirds financed by concessional loans. into two areas: (i) public finance instruments to strengthen the effective- ODA to LDCs, SIDS and LLDCs are largely in the form of grants—90, 91 and ness of development cooperation and (ii) challenges countries face in 93 per cent, respectively. However, since 2015, there has been a decline in graduation from concessional finance windows. It concludes with an concessionality for LDCs and LLDCs (figure III.C.4). For LDCs, concessional- update on development cooperation effectiveness. ity fell across all sectors, although the decline was more pronounced in economic sectors, particularly for projects related to transport and storage. 2. Trends in international Measuring official development assistance for the Sustainable Development Goals development cooperation To better track the contribution of ODA to the SDGs, the OECD is introducing an SDGs tracker, which uses artificial intelligence to link ODA and other 2.1 Official development assistance development flows to the SDGs. For example, according to the tracker, in 2017, 16 per cent of gross ODA disbursements by DAC members were In 2018, ODA provided by members of the Organization for Economic dedicated to the achievement of SDG 10 (reduced inequalities), 11 per cent Cooperation and Development (OECD) Development Assistance Com- towards SDG 3 (good health and well-being), and 10 per cent each to SDG mittee (DAC) amounted to $153 billion, as calculated by the new OECD 2 (zero hunger), SDG 16 (peace, justice and strong institutions) and SDG 17 grant-equivalent methodology (box III.C.1). The 2018 figure is equivalent (partnerships) (figure III.C.6). to 0.31 per cent of the combined gross national income (GNI) of the DAC, well below the United Nations target of 0.7 per cent. Five DAC members The breakdown of ODA by SDGs is derived from a machine-learning algo- (Denmark, Luxembourg, Norway, Sweden and the United Kingdom of Great rithm based on the creditor reporting system (CRS) database. To link the Britain and Northern Ireland) met or exceeded the 0.7 per cent target. projects to the SDGs, the algorithm “reads” the textual description of each aid project, identifies patterns of text attributed to SDGs and links a project Using the previous cash-flow methodology for comparative analysis, total to zero, one or multiple SDGs. net ODA to developing countries fell by 4.3 per cent in 2018 (figure III.C.1). ODA to LDCs fell by 2.1 per cent and accounted for only 0.09 per cent of The OECD will also continue to measure the SDG alignment of devel- DAC members’ GNI, below the 0.15-0.20 per cent LDC target. The same opment finance more broadly,1 and also refine the algorithm going five DAC members that met the 0.7 target also met the target for LDCs. forward. Quality checks and verification against other markers are being ODA to Africa, landlocked developing countries (LLDCs) and small island assessed to fine-tune the results, as in its current form the algorithm may developing States (SIDS) all fell by 1.8, 8.9 and 2.1 per cent, respectively underestimate SDGs to cross-cutting areas, such as gender. For example, (figure III.C.1). according to the CRS gender marker on preliminary figures, bilateral aid focused on gender equality and women’s empowerment is increasing, ODA allocation accounting for 46 per cent of total bilateral allocable aid in 2018 (figure III.C.7), well above the SDG tracker of 2 per cent. However, the CRS gender The fall in gross ODA disbursements was due in large part to a fall in marker found that programmes dedicated to gender equality and wom- ODA for refugees in donor countries (figure III.C.2). Country program- en’s empowerment as the principal objective amounted to 4.5 per cent of mable aid (CPA), which is provided cross-border to countries and regions DAC members’ total aid, which is more in line with the machine-learning (and excludes donor refugee costs, humanitarian aid, debt relief, and algorithm results. 82 INTERNATIONAL DEVELOPMENT COOPERATION

Figure III.C.1 Total Net ODA by DAC members by country group on a cash basis, 2015–2018 (Billions of United States dollars, 2017 constant prices)

Developing countries 110 12 10 105 8 6 100 4 2 0 95 –2 –4 90 –6 2015 2016 2017 2018

Net ODA by DAC Donors Percentage change (right axis)

Least developed countries Landlocked developing countries

30 15 20 10

25 10 15 5 20

15 5 10 0

10 0 5 –5 5

0 –5 0 –10 2015 2016 2017 2018 2015 2016 2017 2018

Africa Small island developing States 30 10 5 100

25 4 20 5 50 3 15 2 10 0 0

5 1

0 –5 0 –50 2015 2016 2017 2018 2015 2016 2017 2018

Source: OECD/DAC data.

2.2 Humanitarian finance harmonized reporting, as well as enhanced coordination.4 However, there are remaining challenges to further consolidating efforts and reducing In 2019, humanitarian response plans and appeals coordinated by the bureaucracy to meet the full potential of the Grand Bargain.5 United Nations required $29.7 billion, of which $18 billion (61 per cent) was received. Together with additional funding contributions outside these response plans and appeals, global humanitarian funding reported was $24.1 2.3 Multilateral development banks billion.2 The 2016 Grand Bargain made by 18 donor countries and 16 aid The Addis Agenda also calls on MDBs to better leverage their balance organizations to improve the efficiency and effectiveness of humanitarian sheets to increase lending for sustainable development, as well as to align finance has resulted in substantial progress.3 Improvements were made in their policies in support of the 2030 Agenda. cash programming, multi-year collaborative and flexible planning/funding,

83 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Box III.C.1 Official development assistance modernization and total official support for sustainable development

Official development assistance modernization In 2019, the Organization for Economic Cooperation and Development (OECD) Development Assistance Committee (DAC) introduced a change to the methodology to calculate official development assistance (ODA), based on the 2014 DAC decision. From 2018, ODA is calculated using a grant-equivalent measure. Under the old cash flow methodology, the full face value of a loan was counted as ODA and repayments were subtracted when they were paid out. The new grant-equivalent methodology calculates the grant portion of a loan by calculating the amount of lending that is concessional (i.e., below market rates), rather than including the full face value. Future repayments are not subtracted from the ODA total. The 2018 figures start a new grant-equivalent ODA series, as the new grant-equivalent figure is not comparable with historical ODA data. However, the OECD will continue to publish ODA data on a cash basis to allow analysis of trends over time. The change in the methodology resulted in slightly higher gross ODA levels (by 2.5 per cent).

Total official support for sustainable development Initiated by the OECD, total official support for sustainable development (TOSSD) is a statistical framework for measuring official external resources and private finance mobilized by official interventions, in support of sustainable development and the Sustainable Development Goals (SDGs). The TOSSD framework aims to capture both cross-border resource flows to recipient countries, as well as data on resources invested to support development enablers, international public goods (e.g., climate change) and to address global challenges. Following the call by the Addis Ababa Action Agenda to develop TOSSD in an open, inclusive and transparent way, the OECD established an International Task Force in July 2017 to develop the TOSSD statistical methodology. In June 2019, the Task Force finalized the first version of the TOSSD methodology. A TOSSD data survey was also carried out, to which 43 countries and organizations responded, identifying new activities that were not previously reported in OECD statistics. The Inter-agency and Expert Group on SDG Indicators agreed that it would be beneficial to include an additional indicator in the SDGs global indicator framework to measure development support in the broadest sense that goes beyond ODA. However, the Expert Group was not fully in agreement with the TOSSD methodology and agreed to the establishment of a working group to further consider the methodology and submit a recommendation to the United Nations Statistics Commission in 2022. Source: OECD, “Modernisation of the DAC Statistical System,” (2019); Economic and Social Council resolution E/CN.3/2020/2.

Figure III.C.2 Gross ODA disbursements by DAC members to developing countries on a cash basis, 2015–2018 (Billions of United States dollars, 2017 constant prices)

120 Country programmable aid

Refugees in donor countries 100 Administrative costs of donors 80 Debt relief Humanitarian aid 60 Multi-sector

40 Other

0 2015 2016 2017 2018

Source: OECD/DAC data.

84 INTERNATIONAL DEVELOPMENT COOPERATION

Figure III.C.3 Country programmable aid by sector on a cash basis, 2015–2018 (Billions of United States dollars, 2017 constant prices) Developing countries 70 Other Social sector 60 Government and civil society Water supply and sanitation Population and reproductive health 50 Health Education 40 Business and other services Economic sector 30 Banking and nancial services Energy Communications 20 Transport and storage 10 Tourism Production sector Trade policies and regulations 0 Industry, mining, construction 2015 2016 2017 2018 Agriculture, forestry, shing

Least developed countries Landlocked developing countries 20 12

10 15 8

10 6

4 5 2

0 0 2015 2016 2017 2018 2015 2016 2017 2018

Africa Small island developing States 25 3.0

20 2.5 2.0 15 1.5 10 1.0

5 0.5

0 0.0 2015 2016 2017 2018 2015 2016 2017 2018

Source: OECD/DAC data.

Trends in lending and capital replenishments $115 billion capital increase, the largest since its establishment in 1964.7 The African Development Fund, the concessional fund of the AfDB, was In 2018, total lending by MDBs rose 4.7 per cent to $71.9 billion (figure also replenished by $7.6 billion for the 2020-2022 period, an increase of 32 III.C.8). Concessional lending, primarily from the International Develop- percent from the previous cycle.8 ment Association (IDA), accounted for about 18 per cent of the total (figure III.C.8), with the major recipients being LDCs (67 per cent). In December 2019, IDA was successfully replenished with $82 billion for Optimization of resources the fiscal years 2021-2023 (IDA19),6 7 billion more than the previous The Addis Ababa Action Agenda calls on MDBs to make optimal use of replenishment in 2016. Also, in 2019, shareholders of the AfDB approved a their balance sheets to increase lending. In 2019, several MDBs9 agreed

85 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Figure III.C.4 Gross bilateral ODA disbursements to country groups by instrument on a cash basis, 2018/2015 (Percentage of total) Developing countries

Grants Loans Equity Developing countries (2015) Developing countries (2018) Least developed countries (2015) Least developed countries (2018) Landlocked developing countries (2015) Landlocked developing countries (2018) Africa (2015) Africa (2018) Small island developing States (2015) Small island developing States (2018) 75 80 85 90 95 100

Source: OECD/DAC data.

Figure III.C.5 Gross bilateral ODA disbursements to country groups by instrument and selected sectors on a cash basis, 2018/2015 (Percentage of total)

Developing countries Grants Loans Equity Total sectors (2015) Total sectors (2018) Social (2015) Social (2018) Economic (2015) Economic (2018) Production (2015) Production (2018) Multi-sector (2015) Multi-sector (2018) 0 20 40 60 80 100

Least developed countries Landlocked developing countries Total sectors (2015) Total sectors (2015) Total sectors (2018) Total sectors (2018) Social (2015) Social (2015) Social (2018) Social (2018) Economic (2015) Economic (2015) Economic (2018) Economic (2018) Production (2015) Production (2015) Production (2018) Production (2018) Multi-sector (2015) Multi-sector (2015) Multi-sector (2018) Multi-sector (2018) 0 20 40 60 80 100 0 20 40 60 80 100

Africa Small island developing States

Total sectors (2015) Total sectors (2015) Total sectors (2018) Total sectors (2018) Social (2015) Social (2015) Social (2018) Social (2018) Economic (2015) Economic (2015) Economic (2018) Economic (2018) Production (2015) Production (2015) Production (2018) Production (2018) Multi-sector (2015) Multi-sector (2015) Multi-sector (2018) Multi-sector (2018) 0 20 40 60 80 100 0 20 40 60 80 100

Source: OECD/DAC data.

86 INTERNATIONAL DEVELOPMENT COOPERATION

Figure III.C.6 Gross ODA disbursements by SDGs, 2017 (Percentage of total)

SDG 10 SDG 3 SDG 16 SDG 4 SDG 7 SDG 11 16% 11% 10% 8% 6% 5%

SDG 8 SDG 13 SDG 1 5% 2% 2%

SDG 2 SDG 17 SDG 9 10% 10% 8% SDG 5 SDG 2% 12 SDG 6 1% 4% SDG 15 SDG 2% 14 1%

Source: OECD SDG Financing Lab based on OECD/DAC data.

Figure III.C.7 Figure III.C.8 ODA to gender equality and women’s empowerment, Lending by multilateral development banks, 2015–2018 2015–2018 (Billions of United States dollars, current) (Billions of United States dollars, 2017 constant prices) 80 7 140 100 70 6 90 120 60 80 5 100 70 50 4 60 80 40 50 3 60 30 40 2 20 40 30 20 10 1 20 10 0 0 0 0 2015 2016 2017 2018 2015 2016 2017 2018 Non-concessional Concessional Principal Signi cant Not targeted Percentage change in total lending (right axis) Percentage of ODA gender focused (right axis) Source: World Bank, International Debt Statistics. Source: OECD/DAC data. to a common “value for money” framework to optimize their resources.10 insurance deal worth $500 million to cover non-sovereign loans, which MDBs have already taken several actions in this area, including merging made headroom of $400 million. The European Bank for Reconstruction concessional windows with ordinary capital; securitizing balance sheets; and Development (EBRD) has used unfunded risk participations, where pri- and insuring or reinsuring risks. For example, the merger of the windows vately owned insurance or reinsurance companies take on the risk exposure of the Asian Development Bank (ADB) is expected to increase annual loan of a portion of EBRD loans, signing €1.2 billion worth of deals since 2014, and grant approvals by over 50 per cent, to over $20 billion by 2020.11 The including over €500 million in 2019.14 AfDB synthetic security (see section 3.2)12 made space for $650 million Mobilization of private finance is one of the indicators of the common more in loans.13 The AfDB and African Trade Insurance completed a credit framework. The total amount mobilized by MDBs amounted to $69.4

87 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

billion, which includes direct and indirect mobilization. Direct mobilization 2.4 Climate finance totalled $20.2 billion in 2018, similar to 2017, with $2.9 billion for LDCs and other low-income countries15 (see section 3.1). According to the Standing Committee on Finance of the United Nations Framework Convention on Climate Change (UNFCCC), climate-specific MDBs also recognized the importance of gender equality as one of the finance provided through bilateral and multilateral channels reported by indicators in the common framework, with an MDB Working Group on developed countries to developing countries amounted to $38 billion in Gender looking to strengthen harmonization of indicators.16 These efforts 2016.18 More recent estimates by the OECD signal an increasing trend in are similar to those currently considered by the United Nations system, both public flows and mobilized private flows for climate action, including following recommendations by a High-level Task Force on Financing for to LDCs and SIDS.19 Climate finance remains skewed towards mitigation Gender Equality. compared to adaptation activities, except in the case of LDCs and SIDS where financing is more balanced.20 The majority of climate finance is Addressing debt risk provided through loans, with grant financing making up about a quarter of Many low-income countries that borrow from MDB concessionally have the public climate finance (figure III.C.9). dual challenges of managing raising resources and rising debt levels (see MDB21 climate finance commitments rose by 22.4 per cent over the year to chapter III.F). For example, more than one third of IDA countries are at high $43 billion in 2018.22 The AfDB recently announced that it would no longer fi- risk of or in debt distress. To help countries manage this risk, the World nance coal projects, joining the World Bank Group (WBG), EBRD and European Bank will replace its non-concessional borrowing policy with the Sustain- Investment Bank (EIB) that have explicit policies in this area. The ADB and able Development Finance Policy (SDFP).17 The objective of the SDFP is Asian Infrastructure Investment Bank (AIIB) also made statements that they to incentivize countries to borrow sustainably and promote coordination do not intend to finance coal.23 In addition, the EIB announced that it would between IDA and other creditors in support of borrowing countries’ efforts. end all fossil fuel lending by 2022.24 At the United Nations Climate Change On the demand side, a Debt Sustainability Enhancement Program (DSEP) Conference (COP25), held in Madrid in December 2019, MDBs indicated that aims to incentivize countries with elevated debt vulnerabilities to imple- the full implementation of the joint framework for aligning activities with the ment concrete policy and performance actions (PPAs) aiming to enhance goals of the Paris Agreement would be implemented by 2023-2024.25 fiscal sustainability, debt management, and debt transparency. Countries In October 2019, 27 countries pledged to replenish the Green Climate Fund successfully implementing their annual PPAs will have access to their full (GCF) by $9.78 billion—equivalent to funding for the next four years—up country allocations; otherwise, a portion of their country allocations will from $9.3 billion in the previous pledging conference in 2014.26 As of be set aside but could be released a year later if PPAs are successfully com- November 2019, the GCF had approved total funding of $5.6 billion for 124 pleted. The second pillar of the SDFP is the Program of Creditor Outreach, projects and programmes, with co-financing of $15 billion.27 LDCs, SIDS which aims to promote stronger collective action and coordination among and African States accounted for 25.0 per cent, 18.8 per and 39.2 per cent borrowers and creditors to mitigate debt-related risks. of approved projects, respectively.28

Figure III.C.9 Climate nance instruments (Percentage)

Public climate nance Mobilized private nance

Investment Simple co- nancing Equity Unspeci ed schemes Guarantee 0% in funds 1% 2% 3% 3% Syndicated loan Grant 9% 24%

Credit line 12% Direct investment in SPVs and companies 52%

Loan Guarantee 73% 21%

Source: OECD, Climate Finance Provided and Mobilised by Developed Countries in 2013-17 (Paris, 2019). Note: SPV – special purpose vehicle.

88 INTERNATIONAL DEVELOPMENT COOPERATION

MDBs and climate finance funds can also capitalize on the unique role of 2.6 South-South cooperation national development banks, including through the International Develop- In March 2019, the second High-level United Nations Conference on ment Finance Club, to crowd in the private sector or intermediate funds. South-South Cooperation (BAPA+40) highlighted the evolution of Even as climate finance flows increase, enhancing access and improving its South-South cooperation (SSC) over the decades, and its emerging role effectiveness remain critical. The accreditation process remains compli- in the implementation of the 2030 Agenda.41 As a complement to cated, time-consuming and disjointed, making it difficult for developing North-South cooperation, SSC has expanded its scope, facilitated regional countries to access, especially those with limited technical capacity.29 integration and provided innovative approaches for collective action.42 Despite ongoing efforts, a more coordinated and complementary approach by bilateral and multilateral agencies is required to overcome the complex The growth of SSC in volume and geographical reach, has also resulted in and fragmented climate finance architecture.30 As women are often dis- context-specific approaches, modalities, instruments, patterns and scales proportionally affected by the climate crisis, gender perspectives should be of SSC, which has made it difficult to develop a common definition of 43 incorporated into operational and policy frameworks, as GCF has demon- SSC and a standardized approach to quantifying SSC flows. strated from the outset.31 More broadly, it is important that development Twenty non-DAC countries that report to the OECD averaged $15.2 billion cooperation activities are aligned with climate action and that develop- in development assistance between 2015 and 2017.44 A few countries ment financing activities do not undermine sustainable development.32 have provided more than 0.7 per cent of their GNI, including Turkey and the United Arab Emirates. Qatar and Saudi Arabia have also previously 2.5 Emergency health finance exceeded the 0.7 per cent threshold. Arab providers account for almost half of non-DAC reported development assistance, with flows directed mainly The spread of the coronavirus (COVID-19) has raised questions of whether through grants for the Middle East and North African region.45 resources are sufficient. The World Health Organization (WHO) estimated that it needed $675.5 million to combat COVID-19. By mid-March 2020, Developing countries are also advancing BAPA+40 calls to WHO received $103.4 million. WHO also received $15 million from the developed-country-led systems for data collection, quality assessment, Central Emergency Response Fund (CERF) and $9.5 million from the Contin- and monitoring and evaluation. For example, the Government of Mexico is gency Fund for Emergencies (CFE). 33 The CERF is a grant-making facility further refining a pilot framework to monitor the effectiveness of its SSC, started in 2006 to fund very early responses to humanitarian emergencies which it developed in 2018. The results of the pilot are also being used to and to support humanitarian response activities, while the CFE gives WHO inform the next iteration of the country’s national development coopera- the resources to respond quickly to disease outbreaks and humanitarian tion policy. crises with health consequences. Other mechanisms to address pandem- Globally, triangular cooperation continues to expand and to enhance its ef- ics include the World Bank Pandemic Emergency Financing Facility (PEF) fectiveness, Voluntary Guidelines for Effective Triangular Cooperation were (section 3.3). However, there are concerns over the sustainability of these launched in 2019, emphasizing country ownership; shared commitments; mechanisms, due to the limited support by donors. For example, only three a focus on results; inclusive partnerships and multi-stakeholder dialogues; donors account for most of the funding to the CFE (75 per cent) and PEF transparency and mutual accountability; innovation; joint-learning and (100 per cent).34 knowledge-sharing; the advancement of gender equality; and leaving no 46 The World Bank has made available a $14 billion package of fast-track one behind. financing to assist countries and companies in their efforts to respond to COVID-19, as well as a number of other facilities that countries can potentially access during crises, including the Contingent Emergency Response 3. Public finance instruments Components (CERCs), the “Catastrophe Deferred Drawdown Option” (see Public finance instruments aim to raise resources for sustainable develop- section 3.3), 35 and the Crisis Response Window (CRW) for IDA-eligible ment and increase the effectiveness of development cooperation. While countries. The IMF has also made available rapid-disbursing emergency some of the mechanisms discussed in this section overlap with the trends financing of about $10 billion for low-income countries and $40 billion laid out in section 2 above (e.g., concessional finance from DAC donors for emerging markets. In addition, the IMF is providing eligible countries used in these instruments is generally included in ODA statistics), these up-front grants for relief on IMF debt service, but this facility is currently “innovative instruments” are meant to complement existing forms of underfunded with just over $200 million available against possible needs development cooperation.47 36 of over $1 billion. Other MDBs have also announced COVID-19 response The concept of innovative public finance in development cooperation 37 38 packages to assist countries – EIB (€40 billion), ADB ($6.5 billion), has evolved considerably since Member States of the United Nations 39 Inter-American Development Bank (IDB) ($2 billion) and Islamic Devel- agreed in the Monterrey Consensus in 2002 to explore such measures. 40 opment Bank ($730 million). While the earlier discussions on innovative finance highlighted solidar- The rapid spread of the COVID-19 outbreak and its impact on global eco- ity taxes to raise resources, along with measures to better manage aid nomic activity reaffirms that investment in prevention and risk reduction flows (e.g., ODA securitization), more recent discussions have focused also makes economic sense (see chapter I). Much greater investment is on leveraging private finance (e.g., blended finance) and sustainable in- therefore needed, particularly in the form of ODA in LDCs and SIDS, to build vestments (e.g., green bonds). Yet, as noted in the Addis Agenda, some technical and governance capacities, share technologies, and strengthen earlier innovative instruments still have the potential to be replicated data for an integrated and systemic approach to risk reduction. and scaled up.

89 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

3.1 Blended finance sector investment that blending is helping to overcome. For example, if the impediment to investment in a big infrastructure project is low expected 48 Blended finance, which uses public funds to crowd in private finance, returns, the solution might be concessional loans. If this is compounded has been used for decades, although interest in it has grown since the by high risk (e.g., political or currency risk) the solution could include adoption of the Addis Agenda. This type of funding is most relevant for risk guarantees. If perceived risks by the private investor are out of line investments necessary for sustainable development (i.e., that have social with the public sector’s perceptions, guarantees could be the cheapest returns), which are not attracting private investment but still have a busi- alternative for public entities, who would be arbitraging the difference in ness rationale and potential cash flows to repay the private partner. The risk perceptions. objective is to unlock investment that the private sector would not have done on its own in support of national development priorities,49 and do The Addis Agenda also calls on countries to share risk and returns fairly in this with minimum concessionality or subsidy (i.e., just enough to make a blended finance. This implies that if there are deals with high upside poten- project attractive to commercial investors).50 tial, the public entity should use instruments with equity-like characteristics that allow it to share in the upside, then use those gains to fund other Between 2012 and 2018, total private finance mobilized by bilateral and investment (see chapter III.B for an in-depth discussion on different instru- multilateral development finance providers grew an average of 21 per cent ments). Blended finance deals should also be disaster-risk informed, clearly annually, to reach $48.4 billion51 (see chapter III.B), with DFIs reporting defining the risk reducing roles and responsibilities of the public and private that $1.1 billion in concessional finance mobilized about $6 billion.52 Of sector to attract sufficient private investment, while ensuring the public the total mobilized, 55.5 per cent targeted the energy and banking sec- sector is not overly burdened by stranded assets in the event of a disaster. tors, while only 5.6 per cent went to projects in social sectors (see figure Yet, even though blended finance has grown rapidly, it has largely III.C.10).53 bypassed LDCs. Approximately $9.3 billion—or 6 per cent of the $157 bil- Concessional resources have been used primarily for three purposes: (i) to lion private finance mobilized between 2012 and 2017—went to LDCs.54 mobilize private investment in infrastructure projects, either by mitigating Blended finance deals in LDCs also tend to mobilize less private finance. investor’s risks through public guarantees, or by providing concessional The average private finance mobilized in LDCs is $6.1 million per deal, loans/grants to reduce project costs; (ii) to facilitate loans by local finance compared to $27 million in lower-middle-income countries and $61 million institutions to underserved segments or priority sectors, for instance via in upper-middle-income countries. 55 concessional loans to microfinance institutions or credit guarantee schemes; The low proportion of deals in LDCs (as well as in conflict and post-conflict and (iii) to increase the supply of risk capital directly to firms, for example, countries56) highlights the fact that blended finance, like private finance, through risk-return enhancing mechanisms such as a first loss tranche. is drawn to areas with lower barriers to private capital mobilization. It can The choice of instrument depends on the sector and type of transaction, as also indicate a tendency of blended finance to focus on less costly projects well as country circumstances and the underlying impediments to private with lower-risk profiles, and potentially lower developmental impacts.57

Figure III.C.10 Amounts mobilized from the private sector by instrument and sector, 2017-2018 (Billions of United States dollars)

Guarantees Syndicated loans Shares in CIVs Simple co- nancing Direct investment in companies and SPVs Credit lines

Energy 12.1 (28.0%) Banking and nancial services 11.8 (27.5%) Transport and storage 2.0 (4.7%) Economic infrastructure Communications 0.6 (1.3%) and services (61.6%) Business and other services 0.1 (0.2%)

Industry, mining, construction 4.5 (10.4%) Agriculture, forestry, shing 1.4 (3.3%) Tourism 0.1 (0.2%) Production sectors (14.0%) Trade policies and regulations 0.1 (0.2%)

Water supply and sanitation 0.9 (2.1%) Health and population and reproductive health 0.8 (1.8%) Other social infrastructure and services 0.3 (0.7%) Social infrastructure Government and civil society 0.2 (0.5%) and services (5.6%) Education 0.2 (0.4%)

Other multisector 0.3 (0.7%) Cross-cutting (1.1%) General environment protection 0.2 (0.5%)

Other, unspeci ed (17.7%) Sectoral breakdown not provided 7.6 (17.6%) 0 2 4 6 8 10 12

Source: OECD/DAC data. Note: SPV – special purpose vehicle; CIV – collective investment vehicle. 90 INTERNATIONAL DEVELOPMENT COOPERATION

For example, while blended finance projects have often mobilized addi- at all, only after the investment decision is made. Changing this could likely tional finance, they have generally had only a modest impact on poverty.58 require countries and partners to create a space where they can agree However, even more often, the developmental impact is unknown, due to on a framework for the usage of concessional resources for private sector weak monitoring and reporting and poor transparency.59 projects—for example, by developing blending strategies. The implication could be that, rather than trying to scale up existing types Second, the primary focus of all blended deals should be development of blended finance transactions, a different approach may be needed. The impact (a shift from a focus on bankability to development impact). Con- approach should also be based on understanding where the impediments cessional resources should be allocated where the impact is the greatest to investments are, before deals are entered. Integrated national financing and not where it is the easiest to make deals. The latter would inevitably frameworks, which include binding constraint analyses—such as the result in LDCs being overlooked by blended instruments. It is easier to country private sector diagnostics by the International Finance Corporation achieve higher leverage ratios in middle-income countries—for example, (IFC)—can be helpful in this process.60 This approach should be firmly by subsidizing lending of a local finance institution rather than support- grounded in country ownership. Projects that are aligned with national ing a venture capital fund in a frontier market. Similarly, concessionality priorities and plans, and that involve local and national actors, are much levels for infrastructure projects are likely to be much higher in LDCs than more likely to have long-lasting impacts. elsewhere. Development partners need to acknowledge this reality and customize blended instruments to local circumstances. DFIs also need to Box III.C.2 reflect this reality in staff internal objectives, so the focus is on delivering impact rather than volumes. Principles for blended finance, extracted from the Addis Ababa Action Agenda Third, analysis should always include measurement of the cost of blending versus other financing mechanisms. For example, the biggest infrastruc- 1. Appropriate use (i.e., financial and developmental additionality) ture needs may be in social infrastructure or other areas that might not 2. Sharing risks and rewards fairly be profitable to private investors, even with enhancements. Water and 3. Alignment with sustainable development sanitation—where commercial viability is often challenging due to equity concerns—has attracted a limited amount of private finance mobilized 4. Clear accountability mechanisms by official development finance (2.4 per cent of the total OECD-reported 5. Transparency amounts mobilized from the private sector),61 while social sectors, such 62 6. Participation, particularly of local communities, in decisions as health, education and gender equality, are scarcely covered. In those affecting their communities cases, public investments might be more appropriate, even if a complex blended deal could be arranged. Indeed, these are the types of cases 7. Effective management, accounting, budgeting for contingent where blended deals could fail or cause a public backlash when the size of liabilities, and debt sustainability the subsidy to the private partner becomes public. 8. Alignment with national priorities, promotion of country owner- Fourth, analysis should include the cost of complementary investments, ship and other relevant principles of effective development as well as prioritization. For example, in the case of credit constraints to cooperation domestic small and medium-sized enterprises, the public sector can offer Source: Addis Ababa Action Agenda of the Third International Conference on concessional lines of credit; but if the constraint is local capacity for credit Financing for Development (Addis Ababa Action Agenda) (United Nations analysis, a credit line on its own will be insufficient. Instead, it should be publication, Sales No. E.16.I.7). coupled with capacity development. Similarly, the policy conclusion might be that it makes more sense to use concessional funds to first strengthen Different groups of actors have defined principles for blending for their the enabling environment, rather than in investment in specific deals own activities, which are in line with principles put forward in the Addis (see chapter III.B). Indeed, strengthening the investment environment Agenda (box III.C.2). These include the 2017 OECD/DAC Blended Finance reduces risks for investors, thus lowering the cost of finance (as opposed Principles for Unlocking Commercial Finance for the SDGs, which were to blending, which shares risks between the public and private parties). endorsed by the OECD/DAC, and the 2017 DFI Working Group Enhanced In other cases, the specific investment can help strengthen the enabling Blended Concessional Finance Principles. environment (e.g., resilient infrastructure, or financial market investments). Building on these principles, countries and development partners should Fifth, capacity development support, including helping countries identify take a six-pronged approach to blending: (i) develop a country blend- and apply appropriate instruments will, in many instances, be crucial ing strategy linked to country needs; (ii) focus on development impact for success. (a search for impact, rather than a search for bankability); (iii) measure Finally, reporting on impact and transparency are critical both to the cost of blending versus other financing structures; (iv) account for decision-making and to monitoring and review, as is participation of complementary investment; (v) provide capacity development; and (vi) stakeholders. Governments and engaged partners should work towards ensure transparency and impact reporting, participation, and monitoring ensuring that blended finance facilities enhance the quality of monitoring, throughout the life of a project. evaluation and, ultimately, sustainable development impact. There are First, deals that include concessional finance should be driven by country some important efforts to address these issues. For example, the IFC an- needs. In many blended finance transactions, Governments are involved, if nounced in October 2019 that it would disclose the estimated subsidy and

91 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

justification for each project as there were concerns over the way it was and (ii) securitization of ODA flows to support investments that have large providing subsidies to companies under the $2.5 billion IDA Private Sector upfront financing needs. Window. For blended finance to become more standardized, effective, MDB securitization, pioneered by the AfDB (see section 2.3) responds and sustainable, more will need to be done, in line with broader efforts to to the Addis Ababa call for MDBs to make better use of their balance improve impact reporting. sheets. Similar to securitization in financial markets (see chapter III.B), this To further efforts in blended finance, the OECD, DFI Working Group, and involves an MDB securitizing (and selling) a portion of its loan portfolio to Indonesia and other Governments are advancing the Tri Hata Karana bondholders. While the MDB gets paid upfront, future loan repayments go Roadmap for Blended Finance through five working groups covering good to repay the bondholders. The MDB offsets some of the risk of default to practices, mobilization, transparency, inclusive markets and impact. the bondholder, allowing the MDB to further increase its lending. Although MDB securitization does not have the same characteristics as mortgage 3.2 Restructuring cash flows or auto-backed securities (which are comprised of diversified portfolios of thousands of small loans), there are still potential risks to this approach. In the mid-2000s, the Leading Group on Innovative Financing for Develop- In particular, there are questions as to how a sovereign’s borrowings are ment introduced several initiatives that were based on restructuring cash treated in the case of default (e.g., does the bondholder have the same flows, building on innovations in private markets. Most of these mecha- incentive as the development bank to work with the borrower (who could nisms aim to make development cooperation more effective, rather than be a sovereign) or to refinance the loan, when feasible?) (see chapter III.E). solely raise resources (although the most recent effort—MDB securitiza- There is also a risk that MDB loan officers, who are sometimes judged tion—raises additional resources for development). As these instruments by deal volume and performance, will have an incentive to lower credit engage in some form of what is often referred to as financial engineering, all standards when they know the loans will be sold to a third party. of them also impact incentives, with some of them (e.g., advanced market commitments) designed for this purpose. The aim should be to ensure that To address these issues, the AfDB created a synthetic securitization, that is, any changes in incentives are aligned with sustainable development. the loans remain on the AfDB balance sheet until they reach maturity. The AfDB then passes any payment from the creditor to the bondholders. To Securitization further align incentives, the AfDB retained 10 per cent of every securitized loan. This is similar to asset-backed structures in private markets, where, Securitization, which converts illiquid assets into marketable securities, following the financial crisis, issuers have been required to hold on to a has been used in at least two ways in development cooperation: (i) secu- portion of debt to “keep some skin in the game”. In scaling up securitiza- ritization of MDB loan portfolios to increase the MDB borrowing capacity tion structures, it will be important to learn from both the successes and

Figure III.C.11 IFFIm nancing model, 2006–2019 (Billions of United States dollars, current prices)

Funds raised in the bond market Donor contributions: United Kingdom France Italy Australia Norway Spain The Netherlands Sweden South Africa Brazil 1.2 US$ 6.1 billion raised on the capital markets (2006–2019) 1.0

0.8

0.6

0.4

0.2

0 200820072006 2009 2010 2011 2012 20142013 2015 2016 2017 2018 2019 2020 2021 2025202420232022 2026 2027 2028 2029 2030 20322031 2033 2034 2035 2036 2037

Source: IFFIm, “Donors,” 2019. 92 INTERNATIONAL DEVELOPMENT COOPERATION challenges of early experiences, including setting the appropriate reten- The pilot AMC was established in 2009 for pneumococcal vaccines, with tion percentage. donors agreeing to $1.5 billion in long-term purchase commitments to In ODA securitization, future ODA commitments are securitized into trad- encourage the development and production of affordable vaccines tailored 67 able bonds to fund development needs today. The financing model of the to the needs of developing countries. The programme proved to be ex- Global Alliance for Vaccines and Immunization (Gavi) provides the most tremely successful, with 59 countries introducing pneumococcal vaccines. successful example of securitization of ODA commitments. 63 The Gavi Despite this success, AMCs have not replicated in other contexts. This could International Finance Facility for Immunization (IFFIm) raised $6.1 billion be due to potentially high research and development (R&D) costs and through offerings on vaccine bonds in the capital markets between 2006 uncertainty fulfilling product specifications once developed.68 The pneu- and 2019 (figure III.C.11).64 Rather than making annual ODA payments to mococcal vaccine, for example, was already in late stages of development the Government, 10 sovereign sponsors used their ODA annual commit- in 2003, before the initiation of the AMC. Others have also argued that ments to repay the bondholders. While this financing model does not AMCs favour large multinationals over disease researchers at non-profit provide additional resources, it front-loads future payments. The nature and public research organizations, and that AMCs buy vaccines already of immunization campaigns provides a strong rationale for front-loading developed rather than accelerate research.69 Nonetheless, AMCs remain resources, as immunization campaigns need to reach a threshold level of an option to spur R&D, and could be explored in areas of new technologies, immunization rates (between 75 and 95 per cent)65 to effectively curb the for example, in digitalization, agriculture, and water scarcity.70 transmission of the disease.66 Although the Addis Agenda encouraged the replication of instruments such 3.3 Instruments for risk management as IFFIm, there has not been much success in this area. In part, this reflects Risk pooling instruments are one of several options, which can be part of challenges associated with creating IFFIm-type structures, which require a broader risk reduction financing strategy. Institutional pooled funds and legally binding, multi-year aid commitments from donors, which some insurance-like instruments can play complementary roles; and greater donors find difficult to accommodate in their budget systems; commit- provision of international resources to both types of instruments could ments are normally recorded when they are made rather than when they bring benefits and greater efficiency compared to the current practice of ex are due. Yet, the successful example of IFFIm shows that this is possible. In post disaster response. the context of the 2030 Agenda, this type of structure could be useful in areas that need front-loading, such as large infrastructure investments, Catastrophe risk pooling potentially as part of blended finance deals. International risk pooling, whether in multiple-country insurance, loans, or Advance market commitments grant facilities, is an advantage of international cooperation. By grouping together well-diversified risks into a single risk pool, the cost of insurance Advance market commitment (AMC) is another innovation that was (and thus the premiums that participants pay) can be reduced. While the pioneered in the health sector in the 2000s. Pharmaceutical companies resources provided by insurance after a disaster are not sufficient to ad- do not necessarily have incentives to develop drugs for diseases that are dress all economic losses, they can provide quick financing for emergency predominant in developing countries, where many people cannot afford response and be designed to align incentives for disaster risk reduction. to buy the drugs. In AMCs, donors agree in advance to purchase drugs at a predetermined price, thus guaranteeing a market, and incentivizing the Since 2007, 32 countries, many of which are SIDS, have joined catastro- drugs’ development. phe risk pools in three regions through the Caribbean Catastrophe Risk

Table III.C.1 Regional sovereign insurance pools Regional pool Hazards insured Member States/territories Premium, coverage, pay-out (established) CCRIF (2007) Earthquake, tropical cyclone (hurricanes), Insured members (21), other eligible members (14) Source of premiums: credits from IDA and the Caribbean excess rainfall, drought Development Bank Average premium: $21.5m Average coverage: $650m Average coverage: $650m PCRAFI (2013) Tropical cyclone, Insured members (3), other eligible members (12) Source of premiums: grants, national budgets, IDA credits earthquake/tsunami, Average premium: $2m excess rainfall Average coverage: $45m Cumulative payout: $3.2m ARC (2013) Drought, extreme weather (drought, Insured members (6), other eligible members (6) Source of premiums: national budgets, grants excess rainfall, heatwaves and tropical Average premium: $22m cyclones) Average coverage: $50m Cumulative payout: $34m SEADRIF (2018) Mainly flood risk Signatories to agreement (6) To be determined Source: Cebotari and Youssef, “Natural Disaster Insurance for Sovereigns” (2020); World Bank, “Sovereign Climate and Disaster Risk Pooling, World Bank Technical Contribution to the G20” (2020).

93 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Insurance Facility (CCRIF), the Pacific Catastrophe Risk Assessment and by the pandemic bond, was designed to disburse funding quickly to stop Financing Initiative (PCRAFI), and the African Risk Capacity (ARC), while a outbreaks of dangerous diseases. However, the PEF was not triggered fourth pool is in the process of being set up (Southeast Asia Disaster Risk during the Ebola outbreak in the Democratic Republic of the Congo in 2018, Insurance Facility (SEADRIF). These pools have relied on development the second worst outbreak on record.77 The coronavirus has raised similar partners for technical and financing capacity, including donor funds for questions of whether existing mechanisms will be triggered, as well as of start-up costs, capitalization, and premium financing (through grants and adequacy. 78 the use of concessional lending instruments, such as from IDA and the Caribbean Development Bank (CDB))71 (Table III.C.1). Another mechanism, the World Bank’s “Catastrophe Deferred Drawdown For insurance to be most effective, sufficient numbers of participants with Option,” is a contingent line of credit that provides immediate liquidity to different risk profiles are required. As not all countries are able to afford countries upon the declaration of a state of emergency in the aftermath the necessary insurance premiums, especially LDCs, donor support could of a disaster. Countries need to be preapproved based on a disaster risk boost participation in the insurance scheme, which would support indi- management programme and macroeconomic framework.79 vidual countries while further diversifying risks and increasing efficiency. For example, premiums for the first pilot season for PACRAFI were fully covered by grants, while countries made partial premium payments in the 3.4 Pooled funds 72 second season. A related innovation in development cooperation is funds that pool public The regional nature of these pools also constrains their diversification, and private resources for a specific issue or theme. To date, these funds given that hazards often impact several countries in a region together. One have been used primarily for health- and climate-related international solution would be to set up a global risk facility. Alternatively, strength- and global public goods.80 These funds link funding and visible outcomes ened public or private reinsurance could further diversify risks across the (results focused), are transparent and appeal to development partners regional funds. This would require further enhancement of regional facili- and the public through clear goals.81 They can also attract private donors ties and insuring diverse participation in the regional pools. and are a major mechanism for philanthropic flows, such as the Bill and Technological advancement is also helping to better predict events and Melinda Gates Foundation (BMGF). more effectively price insurance (see chapter III.B). However, improved In the health sector, the Global Fund for AIDS, Tuberculosis and Malaria predictions can also lead to effectively excluding countries and regions (Global Fund) and Gavi accounted for almost a quarter of total ODA for with the highest risk, underscoring the importance of the use of develop- health between 2015 and 2017 (figure III.C.12). In 2019, the Global Fund ment cooperation to ensure that no one is left behind. Yet, given the was replenished by $14.02 billion for the 2020-2022 period,82 while rapidly changing landscape caused by climate change, it is also important Gavi is seeking a replenishment of at least $7.4 billion in 2020 for the to address narrowly defined triggers. Because they are based on big data 2021-2025 period.83 that inherently compiles past events, they might need to be adjusted to be broad enough to protect countries against related risks (similar to the In the climate space, there is a proliferation of funds.84 The UNFCCC pandemic bond described below). has several dedicated climate funds, including the GCF, the Adaptation Fund, the Global Environment Facility (GEF), the LDC Fund and Special Additional mechanisms for addressing catastrophes Climate Change Fund. Outside the UNFCCC financial mechanism, there are Catastrophe bonds (CAT bonds) enable sponsors to transfer catastrophe many climate-related funds managed by various United Nations agen- risk to capital market investors through a special purpose vehicle that cies and MDBs. provides protection like an insurance policy. 73 Since 2014, the World Bank has issued several catastrophe bonds, including a pandemic bond of $425 Despite their success in mobilizing resources, global funds are criticized for 85 million in 201774 and a $1.36 billion multi-country earthquake bond in contributing to the fragmentation of the aid architecture. These issues 2018—the Pacific Alliance countries (Colombia, Chile, Mexico and Peru) are quite apparent in the complex climate finance architecture, given CAT bond.75 the numerous funds, different implementing agencies, and bureaucratic processes, which make it difficult for countries, especially LDCs and SIDS, to In these bonds, Governments pay a premium (e.g., a coupon to the access climate funds. bondholders) in exchange for protection in the case of disasters. Donors can help with premium payments—such as for IDA countries in the case These funds are strongest when they can help build capacity in countries of the pandemic bond—while simultaneous issuance—such as for the that is sustained over the longer term. New funds are often proposed across Pacific Alliance countries CAT bond—provides diversification for investors, sectors (e.g., see chapter IV for a proposed fund to build statistical capacity). as well as economies of scale and pricing advantages for issuers.76 In Before establishing a fund, the benefit of pooling should be clear. Will it addition, as the World Bank issues these bonds, they do not contribute to be more transparent and/or accountable? Can it attract additional funds countries’ debt. from philanthropy and/or raise greater donor interest? How does it fit in As with insurance, setting triggers so that the bonds deliver when with country plans, and are benefits transferred to the country level? Are needed, while providing the returns that investors demand, is difficult. there benefits in terms of capacity development? Ensuring complementar- For example, following the Ebola crisis in 2014, the Pandemic Emergency ity, transparency, accountability and streamlined administrative processes Financing Facility (PEF), a parametric-based insurance programme funded should be key elements in the design and implementation of any new funds. 94 INTERNATIONAL DEVELOPMENT COOPERATION

Figure III.C.12 Funding to the health sector by donor, 2000-2017 (Billions of United States dollars, 2017 constant prices) 20 Other DAC United States Other multilateral WBG Gavi Global Fund Non-DAC Other private BMGF

0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Source: OECD/DAC data. 3.5 Additional mechanisms to raise new resources for marine and fisheries projects.90 (A discussion of green bonds and related development cooperation instruments can be found in chapter III.B.) Solidarity taxes 4. Graduation and access to Coordinated internationally but implemented nationally, a solidarity tax is levied to provide funding towards a public good. Solidarity taxes (e.g., concessional finance carbon taxes) are often designed to also impact incentives. As developing countries graduate to higher income per capita status, The most successful international solidarity tax, a levy on airline tickets access to grants and concessional finance windows declines. Terms of pioneered and implemented by France, and currently also applied by two finance can become more expensive, including both higher borrowing other countries, funds UNITAID, a global health initiative that invests in costs and shorter maturities. The situation is particularly challenging for innovations to prevent, diagnose and treat HIV/AIDS, tuberculosis and those graduates that are highly vulnerable to external shocks and disasters, malaria. Between 2006 and 2018, 62 per cent of the $3.1 billion contribu- especially extreme weather events, which can cause countries’ develop- tions to UNITAID came from air ticket levies.86 ment prospects to backslide.91 A second initiative, UNITLIFE, was launched in 2015 to help finance the fight against malnutrition in sub-Saharan Africa. Initial plans for the initia- 4.1 Impact of graduation tive to be funded by a micro-levy on the extractive industries were not In the context of international development cooperation, “graduation” can 87 successful, and it is now looking to be funded through micro or small refer to three separate events: graduation from multilateral concessional 88 donations through digital platforms. assistance, from LDC status, and from ODA eligibility. A key determining Proposals for a financial transaction tax (FTT)—a tiny tax on transactions, factor of all three contexts is a country’s per capita income, although other such as equity trades, bonds, currencies or derivatives—to finance devel- factors are also considered (see table III.C.2). Graduation from multilateral opment have also not materialized. Many countries have imposed FTTs for concessional assistance, particularly the concessional windows at MDBs, domestic resource mobilization purposes but generally do not earmark is based primarily on per capita income, along with creditworthiness. proceeds for international development.89 Graduation from LDC status is based on income per capita, vulnerability and the level of human assets. Graduation from ODA eligibility is based on Innovative bonds instruments income per capita alone. Countries’ access to concessional finance from Green bonds and similar instruments, such as SDGs-linked bonds, have bilateral providers and some global funds may also be impacted as income grown significantly since the EIB and the World bank issued the first green per capita rises. bonds in 2007-2008. The World Bank was also the first to issue an SDGs bond in 2017. MDB issuance of such bonds helped to build a broader green Impact of income graduation bond market. MDBs and development partners have also supported gov- Recent research indicates that despite the loss of access to some sources of ernment issuance (e.g., the Seychelle’s “blue bond”) to support sustainable concessional finance, reaching middle-income status does not necessarily 95 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

result in a decline in ODA. 92 In fact, ODA generally increases when countries’ this problem, while others appear to have overcome it.94 Those countries per capita income rises above the low-income threshold, and only falls when that were able to overcome the financing gap generally did so over time; countries reach upper-middle-income or high-income country levels. tax revenues did not necessarily increase consistently, and there were Nonetheless, ODA falls as a percentage of gross domestic product (GDP) periods when tax revenue and ODA both fell. For some countries, it took as countries’ incomes grow. Even though tax revenues rise in per capita tax revenues more than 10 years to rise sufficiently to offset the decline in 95 terms, total public finance as a percentage of GDP declines—the so-called concessional finance relative to GDP. In addition, countries faced higher 96 “missing middle” challenge.93 The evidence on the depth and breadth interest rates and shorter maturities on new borrowing, and almost a 97 of this challenge is mixed in this area, with some countries experiencing quarter faced debt sustainability issues.

Table III.C.2 Major multilateral concessional assistance Multilaterals Concessional Type Eligibility criteria Transition Phase Graduation criteria Reverse Instruments Graduation European Institutions European Development Grants A African, Caribbean and Pacific - - - Fund countries, European Union overseas countries and territories IMF Extended/Standby/ Loans Low income countries (LICs) (GNI per - Non-LICs (GNI per capita >$1,025) - Rapid Credit Facilities capita <$1,025) World Bank IDA Grants, Loans GNI per capita <$1,175 (cut-off), Blend countries: below cut-off and GNI per capita >$1,175 and cred- Yes

MDBs insufficient creditworthiness, with creditworthy for International Bank itworthy (IBRD-only countries) small economy exceptiona (IDA- for Reconstruction and Develop- only countries) ment (IBRD) Gap countries: above cut-off for 2 years but not creditworthy for IBRD. AfDB African Development Grants, Loans GNI per capita <$1,175 (cut-off), Gap countries: meets cut-off but GNI per capita above >$1,175 and Yes Fund (AfDF) insufficient creditworthiness (AfDF not creditworthy; Blend countries: creditworthy (AfDB countries) countries) below cut-off but creditworthy; Graduating countries: above cut-off and creditworthyb ADB Asian Development Grants GNI per capita <$1,175 (cut-off) Group B OCR blend countries: GNI per capita >$1,925 and Not Fund or LDC, insufficient creditworthi- below cut-off or LDC with limited creditworthy (Group C Regular specified ness, level of debt distress (Group creditworthiness; or above cut-off OCR countries) Regional development banksRegional development Concessional Ordinary Loans A grants-only, AsDF blend and COL with limited creditworthiness Capital Resources (OCR) countries) Lending (COL) IDB IDB Grant Facility Grants GNI per capita <$2,919 (cut-off) Above cut-off but less than 2 GNI per capita >$2,919 and/or Not and/or insufficient creditworthiness consecutive years and/or lack of creditworthiness specified Concessional Financing Loans (Group D2 countries) c creditworthiness Global Global Fund to fight HIV Grants LICs and middle-income countries Lower-middle-income countries High income country status, Yes fund AIDS, tuberculosis and (MICs) (GNI per capita ≤$12,375), with low/moderate disease upper-middle-income countries malaria disease burden indicators for HIV burden and upper-middle-income with low or moderate disease (health), tuberculosis and malariad countries projected to transition burden within 10 years focus on transition

Global health fundsGlobal health preparedness. Once ineligible, up to 3 years of transition funding is provided. Gavi Global alliance for vac- Grants GNI per capita ≤$1,580 over the Phase 1 countries: above LIC thresh- Above cut-off and no longer Yes cines and immunization past 3 years (cut-off) Gavi-eligible( old but below cut-offe; Phase 2 receiving Gavi support (Phase 3 countries) countries: above cut-offf countries)

Source: UN DESA, compiled from reports by multilaterals. Note: a A “small island exception” (SIE) has been in place since 1985, which accords terms enjoyed by IDA-only countries to small island economies (islands with populations less than 1.5 million) that would otherwise not have qualified. In 2017, this was extended to all IDA-eligible small States (countries with populations less than 1.5 million) for the eighteenth replenishment of IDA resources (IDA18). In 2019, the SIE was further extended to IBRD-only small islands if their per capita income was below the IBRD graduation threshold (Graduation Discussion Income), were highly vulnerable to disasters and climate change, had limited creditworthiness for accessing commercial credit, and access to IBRD was constrained by creditworthiness or affordability considerations (ability to borrow non-concessional resources sustainably). b Graduating countries are still eligible for AfDF loans, but at hardened terms during a 2- to 5-year phasing-out period. c Of the countries in Group D2 (Guyana, Honduras, Nicaragua and Haiti), only Haiti is eligible for grants. d LICs and lower-middle-income countries are eligible regardless of disease burden. Upper-middle-income countries are eligible if disease burden is met. Upper-middle- income countries that receive IDA under the SIE are eligible regardless of disease burden. e Countries remain in Phase 1 for 2 more years if above cut-off but experienced more than 30 per cent single-year increase in GNI per capita in the previous 5 years or experienced a more than 20 per cent single-year increase in GNI per capita in the previous 5 years and have less than 90 per cent coverage for a certain pentavalent vaccine. f Transition assessments are completed as early as feasible during Phase 1 and 2-3 years before projected date for entering Phase 2. 96 INTERNATIONAL DEVELOPMENT COOPERATION

Once countries reach upper-middle-income and high-income levels, they The LDC graduation process generally takes at least six years. Most are generally in better positions to withstand declines in ODA, as many graduating LDCs had already reached the upper end of middle-income have been less dependent on aid for a longer period and their economies status at the time of graduation. Of all the LDC graduates, Cabo Verde is have developed considerably since graduation from low-income status.98 the only country whose per capita income remained on the lower end of middle-income status both pre- and post-graduation. There is also grow- Impact of graduation from multilateral concessional assistance: the ing engagement with non-DAC donors, who also provide non-concessional case of IDA graduation finance after graduation.107 To date, 44 countries have graduated from IDA, the majority of which LDC graduation can be triggered if any two of the three criteria (income per graduated in the 1970s. Twelve countries have reverse graduated (i.e., they capita, human assets and vulnerability) are met. In most cases, the vulnera- have re-gained access to IDA), with three eventually graduating a second bility threshold is unmet. For example, Maldives had to recover/rebuild from time and nine maintaining access to IDA.99 a devastating tsunami prior to graduation, underscoring the risks faced by SIDS and countries particularly vulnerable to disasters. Some LDC-specific IDA graduation is an important and highly visible signal,100 influencing support measures are extended for a limited time to ensure smooth transi- the action of other donors, 101 including other MDBs whose instru- tion. For example, the LDC Fund can support projects that were approved ments are closely aligned to IDA graduation criteria (see table III.C.2). A pre-graduation.108 However, for LDC graduates that lose priority access to multi-stage graduation process is triggered when per capita income the GCF, they do not currently have any specific transition support. exceeds an operational cut-off, currently $1,175, at which point a country is no longer eligible for IDA grants. Once a country is assessed as being IBRD creditworthy (based on political risk, debt burdens, growth prospects Impact of graduation from the global health funds and other factors), IBRD financing is phased in. The process typically takes Graduation from the global health funds is tied to a country’s income level multiple years and is accompanied by a graduation task force that aims to and are generally targeted to low- and lower-middle-income countries, ensure a smooth path of transition. IDA graduates continued receiving ODA although upper-middle-income countries have access to the Global Fund well after graduation, albeit with more expensive terms of finance.102 depending on disease burden (see table III.C.2). At the end of 2019, nine 109 IDA graduation and transition policy was recently reviewed and strength- countries had graduated from the Global Fund, while 19 countries 110 ened to provide better transitional support to IDA graduates.103 The small have graduated from Gavi. island exception, which has been in place since 1985, allows small island Both health funds have made efforts to review and update their eligibility, economies (populations less than 1.5 million) continued access to IDA. transition and graduation policies to account for the challenges that coun- In 2017, this was extended to IDA-eligible small States, which benefited tries face with graduation, including allowing for reverse graduation.111 Bhutan, Djibouti, Guyana and Timor-Leste. In 2019, this was further Co-financing requirements that gradually increase with income per capita extended to IBRD-only small island economies based on income, vulner- also support countries’ transition out of support. However, although coun- ability and creditworthiness criteria, which benefited Fiji. An exceptional tries are expected to make up for the loss in concessional funds from public allowance was also made to Jordan and Lebanon, in response to the Syrian budgets, the reallocation to replace donor funding was relatively minimal refugee crisis.104 The World Bank is also exploring providing recent IDA (less than 1 per cent of GDP).112 graduates access to the IDA Crisis Response Window (CRW) and regional For the global health graduates, a major concern is the simultaneous programme during IDA19. These windows provide additional resources to graduation of countries from several global health funds,113 as well as help eligible countries respond to severe economic crises, as well as major from IDA (e.g., Cameroon, Nigeria and Pakistan) and LDC status (e.g., Sao humanitarian and climatic disasters. Tome and Principe). This underscores the need for a coordinated approach and system-wide perspective to graduation plans, aligned with health Impact of LDC graduation sector strategies on universal health coverage.114 To date, five countries have graduated from LDC status: Botswana (1994), Cabo Verde (2007), Maldives (2011), Samoa (2014) and Equatorial Guinea Impact of ODA graduation (2017). LDCs are generally not explicitly targeted for multilateral conces- When a country graduates from the DAC ODA list, aid it receives is not sional assistance. Exceptions are the ADB and the European Development reported in official ODA statistics. However, ODA graduates can and do Fund, which prioritizes LDCs (see table III.C.2). LDCs also have access to the receive concessional support, albeit to varying degrees. EU members still Least Developed Country Fund (LDCF) managed by the GEF, which was set receive grants from the EU through the Cohesion Fund.115 Barbados up in 2001 to support LDCs in climate change adaptation. and Trinidad and Tobago have also received grants under the European Although some bilateral donors tend to prioritize their support towards Development Fund.116 These exceptions are indications that ODA gradu- LDCs, LDC graduation has not generally had a direct impact on concessional ates may still require support, despite reaching a higher level of income financing flows. However, as countries increased their non-concessional per capita, underscoring that the level of development is not necessar- borrowing, the overall terms of finance became more expensive.105 The ily synonymous with the level of income, as development is a complex, impact of LDC graduation on trade, however, can be more pronounced, continuous process that can be reversible.117 affecting 3-4 per cent of their merchandise export revenues, due to the The challenges faced by countries transitioning to upper-middle-income or loss of preferential market access, such as from the European Union (EU) high-income status and graduating from ODA have led some providers to 106 Everything But Arms initiative and Generalized System of Preferences. rethink international cooperation, moving from graduation to gradation.118 97 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

This means that allocation of concessional finance would still decline as linked to country circumstances at the time of graduation (macroeconomic, countries become wealthier, but middle-income countries would be eligible debt levels and fiscal space, poverty and social conditions, etc.). A related for financing for specific projects/sectors, such as regional or global public factor is a country’s ability to tap capital markets, along with the cost of capi- goods, possibly with differentiated financing options that reflect country tal and the non-financial terms of the debt (which are based on the country’s contexts and project characteristics. In 2018, the EU set up a Regional credit quality and rating). A country’s reliance on concessional funding Facility for Development in Transition for Latin America and the Caribbean prior to graduation also matters.125 Second, vulnerability to economic, to assist countries in their transition process. The OECD/DAC also recently political, climatic shocks and other hazards can derail successful graduation. agreed to a process of reverse graduation, prompted by challenges countries Flexibility in transition processes can help countries in these situations. Third, faced due to climatic events. There are also suggestions for countries and relationships with partners remain important post-graduation.126 development partners to develop a strategy of cooperation beyond ODA, including technical assistance, regional, and triangular cooperation.119 Graduation strategies These lessons inform strategies for graduating countries and partners: First, 4.2 Addressing vulnerability and building resilience planning prior to graduation is needed to ensure a holistic and pragmatic The impact of the increased frequency and intensity of climatic events and approach to transition. Simultaneous graduations underscore the need to other hazards can set back years of progress for some graduating countries. plan the sequence and magnitude of the different elements of graduation. Member States of the United Nations have invited development partners This requires a coordinated approach and system-wide perspective. It to use LDC indicators, including vulnerability, as criteria for allocating includes a disaster risk strategy and investing in appropriate infrastructure. donor support.120 INFFs,127 including using the OECD transition finance toolkit,128 can help link financing to development/transition strategies and uncover gaps that ODA providers have generally been responsive to graduates’ vulnerability require transition support. to climatic events (and conflict/political instability), albeit in a reactive way. A more proactive and systematic approach in transition support to deal Second, capacity development prior to graduation is important across with vulnerability and building the resilience of all graduates can smooth sectors. It should be targeted at areas where financing and programmatic the transition process and help more countries achieve the SDGs. gaps might be most critical. This varies by country but would often include strengthening domestic resource mobilization; public financial and debt SIDS are considered some of the most vulnerable countries, particularly to management; financing for disaster risk reduction; and strengthening natural disasters and climate change,121 and are sensitive to the impact governance and institutional capacity, including the enabling busi- of graduation in all contexts.122 The majority of SIDS are upper-middle- ness environment for private investment. Countries may benefit from income countries: seven have graduated from ODA, with two more non-traditional modalities of support and technical assistance, including expected to graduate by 2021. Exceptional and targeted concessional through peer learning, South-South cooperation and triangular cooperation. support for SIDS has been crucial in their smooth transitions. Third, development partners should continue to build in flexibilities to As noted, IDA and several regional development banks’ concessional reflect country vulnerabilities. Many of the graduation processes now have facilities include exceptions that allow small island developing States to flexible, multi-stage transition processes in place. Continued pragmatic access concessional funding even if they exceed income thresholds. The policy responses and support is important to benefit graduates, particu- World Bank recently used vulnerability criteria among other indicators to larly more vulnerable lower-middle-income countries. Reverse graduation extend its IDA small economy exception and is also considering opening processes are also needed for those countries facing difficulty transitioning. access to the CRW to recent IDA graduates.123 SIDS that have graduated from ODA also continue to access the European Development Fund, Flexible approaches and exceptional support, on a case-by-case basis, have which uses an economic vulnerability index in its country allocations also assisted struggling ODA graduates. However, many in this category formula.124 Spurred by the major hurricanes that hit several Caribbean have coped better than others during transition, and support for ODA islands in 2017, the OECD/DAC agreed to rules that would make it possible graduates should not be at the expense of support for LDCs and other for countries to become reinstated for ODA eligibility if their per capita vulnerable countries. income fell back below the World Bank’s high-income threshold for Fourth, cooperation with development partners as countries go through one year. However, the DAC continues to negotiate an agreement on a the graduation process remains important. It includes expanding technical process to allow temporary access to countries following a catastrophic assistance, accessing non-concessional instruments from MDBs, and humanitarian event. leveraging regional programmes and triangular cooperation. The graduation process is also an opportunity to strengthen support to countries on disaster risk reduction. Graduating countries should have disaster risk reduction strategies in place, supported by disaster risk 5. Quality, impact and effectiveness of reduction financing strategies that inform integrated national financing frameworks (INFFs). development cooperation 4.3 Lessons from graduation experiences 5.1 Development coordination and cooperation There are several lessons from graduation experiences. First, prior conditions Country ownership, which remains central to the impact and effectiveness of matter. The successful transitioning away from concessional facilities is development cooperation, begins with the establishment of strong national 98 INTERNATIONAL DEVELOPMENT COOPERATION development plans. Governments have made significant progress in this frameworks, and only 50 per cent align with their statistics and monitoring area since the start of the decade, including the integration of the 2030 systems. Countries also report that medium-term predictability is declin- Agenda. Since 2011, the proportion of partner countries with national devel- ing, with limited provision of forward expenditure and implementation opment strategies assessed as high-quality has almost doubled, from 36 to plans by development partners.132 63 per cent. Nearly all strategies (90 per cent) approved from 2015 onward While developing-country Governments have strengthened their public reference the 2030 Agenda and/or the SDGs, and developing-country financial management systems, including through gender budgeting, Governments are consulting a broad range of national stakeholders in the development partners increased their use only marginally: in 2018, 53 per design of their plans. Nonetheless, as noted in the Financing for Sustainable cent of development cooperation disbursements to the public sector used Development Report 2019, most national strategies do not spell out in detail country systems, compared to 49 per cent in 2010. how they will be financed. Only 73 per cent of partner countries link development strategies with resources needed for implementation. 129 In addition, while the share of untied ODA increased from 81 per cent in 2015 to 82 per cent in 2018, progress has been uneven across development Integrated national financing frameworks, as called for by the Addis partners and is not reaching all partner countries. Moreover, ODA is not Agenda, are a tool that can help link financing to development strategies, fully untied in practice, with contracts being largely awarded to companies and strengthen countries’ planning processes and country ownership. based in DAC countries.133 National development cooperation policies can help mobilize and align international development cooperation with their country priorities within an INFF. Preliminary results from the 2020 Development Cooperation 5.2 Multi-stakeholder partnerships Forum Survey indicate that almost two thirds of countries surveyed had a Effective multi-stakeholder partnerships can support implementation of national development cooperation policy or similar strategy in place. the SDGs, including through INFFs, by bringing together different sectors, As countries establish INFFs, associated shifts are likely needed in coordina- approaches (public service mandate, people focused or market based), and 134 tion structures and mutual accountability mechanisms to consider more complementary resources (technological, human, social or economic). diverse finance sources and a plurality of partners. Access to reliable One challenge is to ensure civil society organization (CSO) participation, information on development finance is important for effective develop- which often facescapacity limitations, as well as limits on inclusiveness. 135 ment planning and budgeting, as well as accountability, as maintained Concerted action by developing countries and development partners through parliamentary oversight. However, most countries currently lack can support CSOs as equal partners, bringing knowledge of local develop- capacity to monitor implementation with only 35 per cent of Governments ment needs and priorities. having data and systems to track implementation of national strategies. A The growing interest within the development cooperation community to recent survey also indicates that the share of development finance subject partner with the private sector to deliver better development solutions to parliamentary scrutiny has fallen.130 places greater focus on the effectiveness and development impact of such Despite considerable strengthening in developing countries’ planning engagements (see discussion in section 3.1). The Kampala Principles are processes, development partners’ alignment to country priorities and a collective effort to promote country ownership, a focus on results and country-owned results frameworks is declining.131 In 2018, while 83 per targeted impact, inclusive dialogue, learning, and scaling up successes, as cent of new projects have objectives aligned to country priorities, only well as recognizing and sharing risks among all partners to ensure greater 136 59 per cent of results indicators are drawn from country-owned results impact on those furthest behind first.

Endnotes 1 OECD, 2021 Global Outlook on Financing for Sustainable Development Report (forthcoming). 2 Funding data for 2019 as reported by donors and recipient organizations to the Financial Tracking Service as of 27 February 2020, available at https://fts. unocha.org. 3 Victoria Metcalfe-Hough, Wendy Fenton, and Lydia Poole, “Grand Bargain Annual Independent Report 2019,” Humanitarian Policy Group Commissioned Report (Overseas Development Institute, June 2019). 4 Ibid. 5 Ibid. 6 World Bank, “Global Community Renews Commitment to the World’s Poorest Countries with $82 Billion,” December 13, 2019. 7 AfDB, “African Development Bank Shareholders Approve Landmark $115 Billion Capital Increase, Signalling Strong Support,” October 31, 2019. 8 AfDB, “ADF-15 Replenishment: Donors Commit $7.6 Billion, a 32% Boost from Last Replenishment, in Support of Africa’s Low-Income, Fragile, Countries,” December 11, 2019.

99 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

9 AfDB, ADB, EBRD, European Investment Bank (EIB) Group, including European Investment Fund, IDB Group, including IDB Invest and the Multilat- eral Investment Fund, and the World Bank Group (WBG), including the International Finance Corporation and Multilateral Investment Guarantee Agency (MIGA). 10 AfDB and others, “Multilateral Development Banks’ Final Report on Value for Money,” 2019, Available at https://www.mof.go.jp/english/international_ policy/convention/g20/annex4-4.pdf. 11 Takehiko Nakao, “How MDBs Can Unlock Private Finance for Development,” ADB, November 30, 2017. 12 AfDB, “African Development Bank, Mariner Investment Group, and Africa50 Price Landmark $1 Billion Impact Securitization,” September 18, 2018. 13 Chris Humphrey, “African Development Bank’s Landmark Deal Opens Door to Scaling up Multilateral Lending,” October 5, 2018; Jon Hay, “AfDB Securiti- zation Opens New Route for MDBs to Leverage Capital,” October 11, 2018. 14 EBRD, “EBRD’s Use of Unfunded Risk Participations (URPs),” 2020. EBRD. 15 Multilateral Development Banks and Development Finance Institutions, “Mobilization of Private Finance 2018,” August 2019. 16 AfDB and others, “Multilateral Development Banks’ Final Report on Value for Money.” 17 IDA, “Addressing Debt Vulnerabilities in IDA Countries: Options for IDA19” (World Bank, June 4, 2019). 18 United Nations Framework Convention on Climate Change (UNFCCC) Standing Committee on Finance, “Summary and Recommendations by the Standing Committee on Finance on the 2018 Biennial Assessment and Overview of Climate Finance Flows” (Bonn, 2018). 19 Organisation for Economic Co-operation and Development, Climate Finance Provided and Mobilised by Developed Countries in 2013-17 (Paris, 2019). 20 Ibid. 21 Group of MDBs composed of AfDB, ADB, EBRD, EIB, IDB, the Islamic Development Bank and WBG. 22 AfDB and others, “2018 Joint Report on Multilateral Development Banks’ Climate Finance.” 23 Sara Jerving, “African Development Bank Commits to Coal-Free Financing,” September 26, 2019. 24 Vince Chadwick, “EIB to End Fossil Fuel Lending by 2022,” November 15, 2019. 25 The Big Shift Global, “Multilateral Development Banks Fail to Deliver on Joint Paris Alignment Promise at COP25,” December 11, 2019. 26 Green Climate Fund, “Countries Step up Ambition: Landmark Boost to Coffers of the World’s Largest Climate Fund,” October 25, 2019. 27 Green Climate Fund, “GCF at a Glance as at 14 November 2019,” November 14, 2019. 28 Ibid. 29 United Nations Framework Convention on Climate Change, “In-Session Workshop on Long-Term Climate Finance in 2019, Summary Report by the Secretariat,” Conference of the Parties, Twenty-Fifth Session (September 6, 2019), Available at https://unfccc.int/sites/default/files/resource/ cp2019_04_advance.pdf. 30 Ibid. 31 Liane Schalatek and Smita Nakhooda, “Gender and Climate Finance,” Climate Finance Fundamentals (Overseas Development Institute and Heinrich Böll Stiftung, November 2016). 32 See OECD, Aligning Development Co-Operation and Climate Action: The Only Way Forward (Paris, 2019). 33 WHO, “COVID-19 Contributions Tracker,” 2020, Available at https://www.who.int/emergencies/diseases/novel-coronavirus-2019/donors-and-partners/ funding; WHO, “UN Releases US$15 Million to Help Vulnerable Countries Battle the Spread of the Coronavirus,” March 1, 2020; WHO, “CFE Supports Novel Coronavirus Preparedness and Response,” February 11, 2020. 34 World Bank Group, “Pandemic Preparedness Financing, Status Update,” September 2019 35 World Bank, “World Bank Group Increases COVID-19 Response to $14 Billion To Help Sustain Economies, Protect Jobs,” World Bank, March 17, 2020; World Bank, “How the World Bank Group Is Helping Countries with COVID-19 (Coronavirus),” March 18, 2020. 36 Kristalina Georgieva, “IMF Makes Available $50 Billion to Help Address Coronavirus,” March 4, 2020. 37 EIB Group, “EIB Group Will Rapidly Mobilise up to EUR 40 Billion to Fight Crisis Caused by Covid-19 and Calls on Member States to Set up a Further Guaran- tee for SME and Midcap Support from EIB Group and National Promotional Banks,” March 16, 2020. 38 ADB, “ADB Announces $6.5 Billion Initial Response to COVID-19 Pandemic,” March 18, 2020. 39 IDB, “IDB Ready to Help Member Countries Address Coronavirus,” March 11, 2020. 40 Islamic Development Bank, “Second Statement on IsDB Group Emergency Response to the Impact of the COVID-19 Pandemic in Member Countries,” March 16, 2020. 100 INTERNATIONAL DEVELOPMENT COOPERATION

41 United Nations, Report of the Secretary-General on the State of South-South Cooperation (A/74/336), Available at https://undocs.org/en/A/74/336. 42 Ibid. 43 Neissan A. Besharati, “Measuring Effectiveness of South-South Cooperation,” Southern Voice Occasional Paper Series, no. 52 (July 24, 2019). 44 Organisation for Economic Co-operation and Development, “Development Finance of Countries beyond the DAC,” 2019. 45 Marisa Berbegal Ibanez, Juan Casado-Asensio, and Katherine Nicolazzo, “Trends in Arab Concessional Financing for Development,” DAC Global Relations, The Development Assistance Committee: Enabling Effective Development (OECD, October 2017). 46 Global Partnership Initiative on Effective Triangular Cooperation, “Voluntary Guidelines for Effective Triangular Co-Operation” (OECD, 2019). 47 While there is no uniformly agreed definition of innovative finance, the Leading Group on Innovative Financing for Development defines it as cross-border flows that ‘raise funds for development that are complementary to ODA, predictable and stable, and closely linked to the idea of global public goods.’ 48 This definition is based on the Addis Agenda. The OECD defines blended finance as the strategic use of development finance and private funds that are governed by a development mandate for the mobilization of additional finance. 49 See Paddy Carter, Nicolas Van de Sijpe, and Raphael Calel, “The Elusive Quest for Additionality,” Center for Global Development Working Paper 495 (Sep- tember 2018). 50 See Paddy Carter and Mark Plant, “The Subsidy Sorting Hat,” CGD Note, February 2020. 51 Organisation for Economic Co-operation and Development, “Amounts Mobilised from the Private Sector by Official Development Finance Interventions in 2017-18,” January 2020. 52 DFI Working Group on Blended Concessional Finance for Private Sector Projects, “Joint Report, October 2019 Update,” 2019. 53 Organisation for Economic Co-operation and Development, “Amounts Mobilised from the Private Sector by Official Development Finance Interventions in 2017-18.” 54 DFIs reported that 19 per cent of blended finance activities supported with concessional finance were in low income countries, while 59 per cent were in activities in lower middle-income countries. 55 Organisation for Economic Co-operation and Development and United Nations Capital Development Fund (UNCDF), Blended Finance in the Least Devel- oped Countries 2019 (Paris, OECD Publishing, 2019). 56 See Irene Basile and Carolyn Neunuebel, “Blended Finance in Fragile Contexts: Opportunities and Risks,” OECD Development Co-Operation Working Paper, no. 62 (November 2019). 57 See “Impact of Development Finance Institutions on Sustainable Development, An Essay Series” (ODI and European Development Finance Institutions, September 2019). 58 Samantha Attridge and Matthew Gouett, “The Impact of Development Finance Institutions: What We Know, What We Don’t and How to Improve,” Impact of Development Finance Institutions on Sustainable Development, An Essay Series (ODI and European Development Finance Institutions, Septem- ber 2019). 59 Ibid. 60 Another potentially useful process is the on-going Structured Discussions on Investment Facilitation for Development at the World Trade Organization. 61 Organisation for Economic Co-operation and Development, Making Blended Finance Work for Water and Sanitation, Unlocking Commercial Finance for SDG 6, OECD Studies on Water (Paris, OECD Publishing, 2019). 62 Irene Basile and Jarrett Dutra, “Blended Finance Funds and Facilities - 2018 Survey Results, Part I: Investment Strategy,” OECD Development Co-Operation Working Paper, no. 59 (July 2019). 63 World Economic and Social Survey 2012, In Search of New Development Finance, UN-DESA. 64 IFFIm, “About IFFIm,” 2019; IFFIm, “Donors,” 2019. 65 The resistance to the spread of a disease within a population that results if a sufficiently high proportion of individuals are vaccinated. 66 World Economic and Social Survey 2012, In Search of New Development Finance, UN-DESA. 67 Gavi, “Advance Market Commitment for Pneumococcal Vaccines, Annual Report, 1 January - 31 December 2018,” 2019. 68 World Economic and Social Survey 2012, In Search of New Development Finance, UN-DESA. 69 Theolis Costa Barbosa Bessa and others, “R&D in Vaccines Targeting Neglected Diseases: An Exploratory Case Study Considering Funding for Preventive Tuberculosis Vaccine Development from 2007 to 2014,” BioMed Research International 2017 (2017): 1–12.

101 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

70 Department for International Development United Kingdom and Chatham House, “Advance Market Commitments for Low Carbon Technology: Creating Demand in Developing Countries,” Meeting Report, April 2010; Kimberly Ann Elliott, “Pulling Agricultural Innovation and the Market Together,” Center for Global Development Working Paper 215 (June 2010). 71 World Bank, “Sovereign Climate and Disaster Risk Pooling, World Bank Technical Contribution to the G20” (Washington, D.C., 2017). 72 World Bank, “Pacific Catastrophe Risk Insurance Pilot, From Design to Implementation - Some Lessons Learned,” July 2015. 73 Abigail Baca and Aki Jain, “Demystifying Catastrophe Bonds for Debt Managers,” Presentation (World Bank, 2018). 74 Ibid. 75 World Bank, “World Bank Affirms Position as Largest Sovereign Risk Insurance Provider with Multi-Country Earthquake Bond,” World Bank, Febru- ary 7, 2018. 76 World Bank, “Super-Sized Catastrophe Bond for Earthquake Risk in Latin America,” Case Study, 2019. 77 The Economist, “The World Bank’s Pandemic Bonds Are Not Paying out for Ebola,” August 29, 2019. 78 Karin Strohecker, “World Bank Pandemic Bond under Pressure as Coronavirus Spreads,” Reuters, February 19. 79 Ede Ijjasz-Vasquez and Armando Guzman Escobar, “Cat DDOs: More than Emergency Lending for Disaster Relief,” September 7, 2017. 80 International public goods benefit a large subset of countries, while global public goods benefit all countries. 81 David Gartner and Homi Kharas, “Scaling Up Impact: Vertical Funds and Innovative Governance,” in Getting to Scale: How to Bring Development Solutions to Millions of Poor People (Brookings Institution Press, 2013). 82 The Global Fund, “US$14 Billion to Step Up the Fight Against the Epidemics,” October 9, 2019. 83 Save the Children, “Not Just a Jab, but a Transformative Investment,” September 12, 2019. 84 Charlene Watson and Liane Schalatek, “The Global Climate Finance Architecture,” Climate Funds Update, Climate Finance Fundamentals (Overseas Development Institute and Heinrich Böll Stiftung, February 2019). 85 World Economic and Social Survey 2012, In Search of New Development Finance. 86 UNITAID, “Audited Financial Statements for the Year Ended 31 December 2018,” 2019, Available at https://unitaid.org/assets/ December-31-2018-Financial-Statements.pdf. 87 Philippe Douste-Blazy and Robert Filipp, “No Pain Big Gain. How Micro-Levies Save Lives,” October 25, 2017; Nisa Patel, “UNITLIFE: A Briefing for Private Sector Partners,” October 2015. 88 UNITLIFE, “Terms of Reference 2018,” 2018, Available at http://mptf.undp.org/document/download/20565. 89 World Economic and Social Survey 2012, In Search of New Development Finance. 90 World Bank, “Seychelles Launches World’s First Sovereign Blue Bond,” October 29 2018, accessed February 21, 2020. 91 See also the discussion in the 2018 Financing for Sustainable Development Report. 92 Lars Engen and Annalisa Prizzon, “Exit from Aid: An Analysis of Country Experiences,” ODI Report (Overseas Development Institute, April 2019); Resina Katafono, “The Impact of Graduation on Countries’ Access to Official Development Assistance,” Background Paper prepared for the 2020 Financing for Sustainable Development Report. 93 Homi Kharas, Annalisa Prizzon, and Andrew Rogerson, “Financing the Post-2015 Sustainable Development Goals” (Overseas Development Institute, 2014); Engen and Prizzon, “Exit from Aid: An Analysis of Country Experiences.” 94 Ibid; Katafono, “The Impact of Graduation on Countries’ Access to Official Development Assistance.” 95 Katafono, "The Impact of Graduation on Countries' Access to Official Development Assistance." 96 Engen and Prizzon, “Exit from Aid: An Analysis of Country Experiences”; Katafono, “The Impact of Graduation on Countries’ Access to Official Develop- ment Assistance.” 97 Katafono, “The Impact of Graduation on Countries’ Access to Official Development Assistance.” 98 Ibid. 99 World Bank, “IDA Graduates,” 2019. 100 Todd Moss and Stephanie Majerowicz, “No Longer Poor: Ghana’s New Income Status and Implications of Graduation from IDA,” Center for Global Develop- ment Working Paper, no. 300 (July 2012). 101 International Development Association, “IDA18 Mid-Term Review - Transitioning out of IDA Financing: A Review of Graduation Policy and Transition Process” (World Bank, October 26, 2018). 102 INTERNATIONAL DEVELOPMENT COOPERATION

102 Katafono, “The Impact of Graduation on Countries’ Access to Official Development Assistance.” 103 Ibid. 104 IDA, “IDA18 Post-Mid-Term Review Amendments, Review of the Small Island Economies Exception and IDA18 Exceptional Allocation to Jordan and Lebanon” (World Bank, April 4, 2019). 105 Katafono, “The Impact of Graduation on Countries’ Access to Official Development Assistance.” 106 United Nations Conference on Trade and Development, “The Least Developed Countries Report 2016: The Path to Graduation and beyond: Making the Most of the Process” (New York Geneva: United Nations, 2016). 107 See IMF, “Maldives : 2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Maldives,” IMF Country Report 19/156 (June 2019); Rachel Morris, Olivier Cattaneo, and Konstantin Poensgen, “Cabo Verde Transition Finance Country Pilot,” OECD Develop- ment Co-Operation Working Paper, The Development Assistance Committee: Enabling Effective Development, 46 (November 2018). 108 United Nations Framework Convention on Climate Change, “Report of the Global Environment Facility to the Conference of the Parties and Guidance to the Global Environment Facility, Advanced Unedited Version,” 2019; United Nations Office of the High Representative for the Least Developed Countries, Landlocked Developing Countries and Small Island Developing States, “A Guide to Least Developed Country Graduation,” 2019. 109 The Global Fund, “The Global Fund Data Explorer,” 2019. 110 Gavi, the Vaccine Alliance, “Transitioning out of Gavi Support,” 2019. 111 See Katafono, “The Impact of Graduation on Countries’ Access to Official Development Assistance.” 112 Ibid. 113 Global Fund and Gavi, as well as from the United States’ President’s Emergency Plan for AIDS Relief and Global Polio Eradication Initiative. 114 UHC2030, “Statement on Sustainability and Transition from External Funding,” 2018. 115 European Commission, “Cohesion Fund,” 2019. 116 Although Bahamas does not receive bilateral support from the EDF, it is eligible to draw on EU support for regional and thematic programmes. 117 Organisation for Economic Co-operation and Development, “Development in Transition,” 2019; OECD, “Next Steps for Development in Transition - A Background Paper” 118 United Nations Economic Commission for Latin America and the Caribbean (ECLAC) and OECD, “Emerging Challenges and Shifting Paradigms - New Perspectives on International Cooperation for Development” (Santiago, 2018). 119 Rachael Calleja and Annalisa Prizzon, “Moving Away from Aid, Lessons from Country Studies,” ODI Report (Overseas Development Institute, December 2019). 120 General Assembly Resolution A/RES/72/231 para 41. 121 International Monetary Fund, “Small States’ Resilience to Natural Disasters and Climate Change - Role for the IMF,” IMF Policy Paper, December 2016. 122 Katafono, “The Impact of Graduation on Countries’ Access to Official Development Assistance.” 123 International Development Association, “IDA18 Post-Mid-Term Review Amendments-Review of the Small Island Economies Exception and IDA18 Exceptional Allocation to Jordan and Lebanon.” 124 European Commission, “Subject: Methodology for Country Allocations: European Development Fund and Development Cooperation Instrument 2014-2020.” 125 See International Development Association, “IDA18 Post-Mid-Term Review Amendments-Review of the Small Island Economies Exception and IDA18 Exceptional Allocation to Jordan and Lebanon.” 126 Rachael Calleja and Annalisa Prizzon, “Moving Away from Aid, The Experience of Chile,” (Overseas Development Institute, December 2019). 127 See 2018 Financing for Sustainable Development Report. 128 See Organisation for Economic Co-operation and Development, “Transition Finance Toolkit,” 2019; Cecilia Piemonte et al., “Transition Finance: Introducing a New Concept,” OECD Development Co-Operation Working Paper, no. 54 (March 2019); OECD, “Transition Finance ABC Methodology: A User’s Guide to Transition Finance Diagnostics,” OECD Development Policy Papers, no. 26 (February 2020). 129 Organisation for Economic Co-operation and Development / United Nations Development Programme, Making Development Co-Operation More Effective, 2019 Progress Report (Paris, OECD Publishing, 2019). 130 Ibid. 131 Ibid.

103 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

132 Ibid. 133 Organisation for Economic Co-operation and Development, “2018 Report on the DAC Untying Recommendations” (Paris, 2018). 134 The Partnership Initiative, “An Introduction to Multi-Stakeholder Partnerships, Briefing Document for the GPEDC High Level Meeting, November 2016,” 2016. 135 Organisation for Economic Co-operation and Development / United Nations Development Programme, Making Development Co-Operation More Effective, 2019 Progress Report. 136 Global Partnership for Effective Development Co-operation, “Kampala Principles for Effective Private Sector Engagement through Development Co-Operation,” 2019.

104

Infographic Goes Here INTERNATIONAL TRADE AS AN ENGINE FOR DEVELOPMENT Chapter III.D International trade as an engine for development 1. Key messages and recommendations

International trade has contributed to economic growth, members are working on new trade rules aimed at reducing poverty reduction and private financial flows across countries harmful fishing subsidies that cause overfishing and overca- supported by strong international cooperation, embodied in pacity. Agriculture negotiations, which historically have been the multilateral trading system. Recent trade tensions have an important issue for developing countries, have also been challenged the way international trade works. Additionally, reenergized. Groups of WTO members are also exploring the COVID-19 crisis will have a significant impact on trade, potential future rules on investment facilitation, e-commerce particularly trade in services. Any response to the crisis that and domestic regulations on services trade, as well as on micro, would further advance protectionism will contribute to slow small and medium-sized enterprises, and empowering women down post-crisis recovery. in the world economy. The WTO Twelfth Ministerial Conference, to be held in Kazakhstan in June 2020, will be a landmark for Despite its considerable achievements, the multilateral trading these efforts. system faces challenges today on a scale unseen for decades. Over the past two years, Governments have introduced trade To enhance the contribution of international trade to sustain- restrictions covering a substantial amount of international able development, immediate action to address two other trade. This trend needs to be reversed. Governments need to issues must be taken by the international community. The first show strong collective leadership and coordination in curbing is to put in place measures to address the ongoing challenges the imposition of new trade-restrictive measures and reduc- faced by least developed countries (LDCs) in international ing the accumulated stock of restrictions. trade. This may include agreeing on possible follow-up to SDG target 17.11, which calls for doubling the LDC share in global Another major challenge for the multilateral trading system is trade by 2020. Such follow-up would include building trade the paralysis of the World Trade Organization’s (WTO) Appellate and productive capacities so that the provision of preferential Body, which no longer has enough members to rule on trade market access to LDCs can contribute more to export growth as disputes. It is important for WTO members to identify poten- well as economic diversification. This would require continual tial solutions to the current gridlock. At the same time, some supportive mechanisms such as Aid for Trade and the members have agreed to work on interim options to keep a Enhanced Integrated Framework. Countries which graduate two-stage dispute settlement mechanism operational while from the LDC category in the coming years could also be a more permanent solution is agreed. provided with temporary market access provisions to ensure The multilateral response to these formidable challenges will a smooth transition and reduce the impact of a sudden loss shape the course of the global economy for decades to come. of preferences. Many members have shown a clear willingness to preserve The second is to upscale actions at the national and the inter- and strengthen the global trading system under the WTO. national levels to better distribute the gains from trade. For They need to turn these words into action. example, the introduction of new technology plays a significant WTO reform should make the multilateral trading system role in helping smaller producers and businesses receive more reactive to twenty-first century geoeconomic realities gains from international trade (e.g., through e-commerce). so it can continue its important role in delivering the 2030 Empowerment through digital technologies can also foster Agenda for Sustainable Development. For instance, WTO the upward mobility of women beyond the informal sector.

107 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

To help small-scale producers and businesses reap opportunities from Other economies’ export growth showed a much more moderate decline. e-commerce and the digital economy, international support must be This pattern contrasts with that of the trade slowdown in 2015 and 2016, increased, including in the form of Aid for Trade, to improve the physical when bilateral trade between China and the United States fared better, on and institutional e-commerce readiness of developing countries. Any average, than trade in the rest of the world. comprehensive rules on e-commerce being explored should also effectively address specific needs of developing countries. Figure III.D.1 Trade growth and trade to GDP ratio Making trade more inclusive also requires addressing trade finance gaps (Percentage) that disproportionally affect smaller companies and impede the ability of countries to seize all trade opportunities that would otherwise be available. 32 25 Multilateral efforts to address trade finance gaps cooperatively need to 20 30 continue, including helping local banks leverage technology to digitalize 15 paper-intensive products and streamline verification processes. 10 28 One possible channel to enhance the positive impact of trade upon 5 inclusive and sustainable development is through sustainable bilateral agreements and regional trade agreements (RTAs) and/or international 26 0 investment agreements (IIAs). Newer generations of such agreements –5

24 (%) rate Growth are designed with a sustainable development orientation, such as –10 economic empowerment of women, respect of basic human rights, and

Trade over global output (%) over Trade –15 environmental sustainability. New or renegotiated agreements should 22 –20 address synergies between trade, investment and socioeconomic and 20 –25 environmental policy, as well as possible negative linkages, and aim to 202220202018201620142012201020082006 distribute economic gains from trade to those who need it most, includ- Real global output Trade ing smaller producers and businesses in developing countries. Trade over global output

Source: UNCTAD secretariat calculations, based on IMF Directions of Trade Statistics, 2. Developments in international and China, United States and EU national statistics. Data for the rest of world exports trade for August and September 2019 are preliminary. Commodity prices also impact the value of merchandise trade and showed 2.1 Trends in world trade a mixed pattern in 2018. For example, food prices fell on average by 6.5 per 3 The value of international trade in 2018 continued to grow, following a cent from 2017, while fuel prices rose by 27.5 per cent. In the first half of 4 strong rebound in 2017 from the negative growth experienced in the pre- 2019, commodity prices were quite volatile. ceding years. The total value of trade in goods and services reached $24.5 Although modest compared to the $19 trillion value of world trade in trillion in 2018, representing about one third of global output. The value goods, the value of world trade in services reached $5.5 trillion in 2018, of South-South trade in goods reached $5.6 trillion in 2018, its highest more than doubling its 2015 value. The categories of services exports that level since 2011. As shown in figure III.D.1, the global trade-to-output ratio, increased most included travel, transport, and information and commu- an indicator of the degree of globalization of economic activity, also rose, nications technology (ICT). Developing countries are becoming important from 27 per cent in 2017 to almost 29 per cent in 2018.1 suppliers of goods-related services, business services and ICT services. Preliminary data for 2019, however, suggests that the value of world trade Global exports of ICT services and digitally deliverable services—services contracted by 3 per cent from the previous year, with initial forecasts for delivered remotely through ICT networks—has grown particularly quickly. 2020 and 2021 indicating moderate growth if ongoing trade tensions among In 2018, exports of digitally deliverable services, at $2.9 trillion, accounted major economies are contained and the international trading environment for 50 per cent of global services exports. Among LDCs, such services more regains stability. However, these forecasts require a downward revision con- than tripled between 2005 and 2018, to reach an estimated 16 per cent of sidering the impact of COVID-19 crisis upon international trade flows. The total services exports.5 crisis could result in at least a $50 billion decrease in merchandise exports The spread of ICT services also enhances the rapid growth of e-commerce across global value chains according to preliminary estimates.2 Trade in (i.e., in-country and cross-border buying and selling of goods and services services, particularly those involving the physical movement of persons such using the Internet). The United Nations Conference on Trade and Develop- as tourism and transport, will also be significantly affected. ment (UNCTAD) estimates that the global value of e-commerce grew by 13 Prior to the crisis, the trade tensions between China and the United States per cent in 2017, to reached $29 trillion, corresponding to 36 per cent of the of America have been a significant trigger of the global trade decline. Trade world gross domestic product (GDP).6 Global business-to-business (B2B) between the world’s two largest economies fell sharply in 2019 (figure e-commerce represents 87 per cent of this amount, while business-to- III.D.2). Bilateral export growth turned negative at the end of 2018 and consumers (B2C) e-commerce accounts for the rest. The top three countries shrank by more than 10 per cent during the first nine months of 2019. in B2C e-commerce sales were China, the United States, and the United

108 INTERNATIONAL TRADE AS AN ENGINE FOR DEVELOPMENT

Figure III.D.2 US-China bilateral trade ows in goods (Percentage change vs same month previous year)

Bilateral United States–China Rest of the world

–10

–20 2014 2016 2018 2020

Source: UNCTAD secretariat calculations, based on IMF Directions of Trade Statistics, and China, United States and European Union national statistics. Data for the rest of world exports for August and September 2019 are preliminary.

Kingdom of Great Britain and Northern Ireland. as the baseline, the LDC share in world exports in 2019 should be about While most online shoppers buy from domestic suppliers, some 21 per cent, 2 per cent. or 277 million people, made a cross-border purchase in 2017, up from 15 Commodity dependency—a state where exports of primary commodi- per cent in 2015.7 Cross-border B2C e-commerce sales, measured by the ties account for more than 60 per cent of a country’s merchandise export value of merchandise exports, is estimated to have reached $412 billion in revenue—is a serious burden on LDC capacity to finance the SDGs, as fluc- 2017—about 11 per cent of total B2C e-commerce sales, up from 7 per cent tuations in earnings from commodity exports directly influence countries’ in 2015. E-commerce is expected to spread widely in the coming years, due public revenues.9 In the period 2013-2017, almost two thirds (64 per cent) partly to the increasing use of mobile money, particularly in developing of developing and transition countries were commodity dependent.10 Of countries (see chapter III.B). the 46 LDCs for which data is available, 39 were classified as commodity 11 By reducing the trade costs associated with distance, e-commerce dependent. allows businesses, big and small, to reach a broader network of buyers; Commodity prices in 2017/18 remained significantly below their 2011 peak access the most competitive suppliers; tap into global markets; and levels, which contributed to worsening external balances and debt sustain- participate in global value chains (GVCs). But, transforming this potential ability indicators for many commodity-dependent developing countries. into reality is not automatic. Currently, wide variations in e-commerce Climate change adds an additional layer of risk and uncertainty for these readiness between and within countries enhances the risk of benefits countries. In 2017, 37 commodity-dependent developing countries, many 8 from e-commerce being unequally distributed. In particular, Internet of which are LDCs, were ranked among the 40 most vulnerable countries access costs, combined with network reliability and quality of e-commerce (i.e., less ready to successfully adapt to climate change).12 A global shift related service, continue to be a major barrier for e-commerce in many towards low-carbon economies also raises uncertainties for countries developing countries. dependent on oil, gas and coal exports.13 There is an urgent need to redress ongoing trade challenges facing LDCs. 2.2 Least developed countries in international trade As a first step, discussion of and agreement on the follow-up to SDG target The share of LDC exports in global merchandise trade remained marginal, 17.11 is imperative. Doubling the share of LDCs in global trade does not at just above 1 per cent in 2018 (figure III.D.3). As regards services trade, necessarily measure whether export growth contributes to the economic LDCs recorded significant year-on-year growth, reaching a global share of diversification of LDCs, which is a necessary condition for sharing gains 0.8 per cent at the end of December 2018. from trade more widely across populations. Indicators such as the product Yet, the speed of growth falls short of achieving SDG target 17.11—that is, concentration and diversification indices or the market concentration and 14 doubling the share of LDCs in global exports by 2020. Using the year 2011 structural changes indices may be considered for this purpose.

109 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Figure III.D.3 Share of LDCs and developing countries in World Trade, 2018 (Percentage)

Share of global merchandise exports Share of global services exports 2 50 50

40 40 1.5 1.5

30 30

1.0 1.0

20 20 Developing regions (%) regions Developing (%) regions Developing Least developed countries (%) countries developed Least Least developed countries (%) countries developed Least

0.5 0.5 10 10

0 0 0 0 2018201620142012201020082006200420022000 2018201620142012201020082006200420022000 Least developed countries (LDCs) Least developed countries (LDCs) Developing regions Developing regions

Source: ITC/UNCTAD/WTO.

Second, support measures to help LDCs accelerate horizontal and vertical trade costs. Trade costs of NTMs are estimated to be more than double that diversification, including into service sectors, must be upscaled. The of ordinary customs tariffs, estimated to be up to 1.6 per cent of global provision of preferential market access to LDCs on a transparent, stable GDP, or $1.4 trillion. At the firm level, business surveys conducted by the and predictable basis remains essential for this purpose. In this context, International Trade Centre show that 56 per cent of the exporters in Asia it would be useful if there were an internationally agreed guideline for and the Pacific and 44 per cent in the Middle East and North Africa regions appropriate transitory market access provisions for countries that graduate are affected by NTMs.15 Sanitary and phytosanitary (SPS) measures and from the LDC category (see chapter III.C). technical barriers to trade account for the bulk of NTMs. The difficulties for companies do not originate solely from the strictness of regulatory require- 2.3 Trade restriction and facilitation ments, but also from related administrative procedures. Common issues include unharmonized product standards among close regional partners; Trade tensions and uncertainty continue to affect trade prospects and inability to prove compliance due to insufficient laboratory facilities in could significantly change the structure of GVCs. WTO members imple- the country; and lack of information on market requirements. The added mented 102 new trade-restrictive measures from mid-October 2018 to costs of complying with NTMs are disproportionately higher for small mid-October 2019. While this represents a decrease in the number of and medium-sized enterprises (SMEs), who lack the financial and human trade-restrictive measures from the previous year, the trade coverage resources to overcome them. of import-restrictive measures is estimated at $746.9 billion, a 27 per NTMs have become a key concern for traders as well as for trade policy- cent increase from the 2017-2018 period and the highest recorded figure makers aiming to ensure that trade can continue to support sustainable since October 2012 (figure III.D.4). Measures included tariff increases, development. Capacity-building support is critical to helping developing bans, quantitative restrictions, stricter customs procedures, import taxes countries addressing challenges emerging from such NTMs. For example, and export duties. the Standards and Trade Development Facility helps developing countries The stockpile of import restrictions implemented since 2009, and still in gain and maintain access to markets by tackling SPS gaps. This facility force, suggests that 7.5 per cent of world imports are affected by import promotes global collaboration on electronic SPS certification, which aims to restrictions implemented over the last decade. Although WTO members improve efficiency and security, as well as reduce time and costs to trade.16 implemented 120 measures aimed at facilitating trade, the trade cover- As shown in figure III.D.5, animal, vegetable and food sectors are particu- age of the import-facilitating measures implemented is estimated at larly affected by NTMs. These sectors face, on average, 11 NTMs per tariff $544.7 billion, approximately $200 billion less than the coverage of new line, compared to 2 or less in other product sectors. Prevalence of NTMs in trade-restrictive measures. These measures largely reduced or eliminated agrifood sectors is particularly high among developed economies (figure tariffs, export duties and import taxes. III.D.6). The effect of NTMs is thus often harsher for low-income countries, Non-tariff measures (NTMs), which include technical and regulatory particularly those whose export basket is tilted towards agricultural requirements, can also be trade-distorting and substantially increase products, and for small firms.17

110 INTERNATIONAL TRADE AS AN ENGINE FOR DEVELOPMENT

Figure III.D.4 Figure III.D.5 Trade coverage of new import-restrictive measures in each NTM in world trade, across sectors, 2018 reporting period (not cumulative) (Average number of NTMs per tari line) (Billions of United States dollars)

800 747 Animal Vegetable 700 Food 588 Chemicals 600 Hides leather Machinery electrical 500 Mineral fuels 400 Transportation Miscellaneous 300 Textiles 201 214 228 Wood 200 Plastics rubbers 101 Footwear 100 79 Stone glass Metals 0 0 3 6 9 12 15 mid-Oct 2012- mid-Oct 2014- mid-Oct 2016- mid-Oct 2018- mid-Oct 2013 mid-Oct 2015 mid-Oct 2017 mid-Oct 2019 Prevalence score

Source: WTO Secretariat. Source: UNCTAD based on TRAINS database.

Figure III.D.6 NTM usage, by product sectors and UN development status, 2018

Frequency index Coverage ratio Prevalence score 1.0 15

0.8

10 0.6

0.4 5

0.2

0 0

LDC LDC LDC LDC LDC LDC

DevelopingcountriesDevelopedcountries DevelopingcountriesDevelopedcountries DevelopingcountriesDevelopedcountries DevelopingcountriesDevelopedcountries DevelopingcountriesDevelopedcountries DevelopingcountriesDevelopedcountries

Agrifood Natural resources Manufactures Agrifood Natural resources Manufactures

Source: UNCTAD based on TRAINS database. Note: The Frequency Index captures a country’s share of tari lines (of products with positive trade) that are subject to at least one NTM. The Coverage Ratio captures the percentage of import value that is subject to NTMs, weighted by import values. The Prevalence Score indicates the average number of distinct NTMs applied on regulated products.

111 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Box III.D.1 Non-tariff measures and the Sustainable Development Goals During the past two decades, tariffs in the Asia-Pacific region have been halved thanks to multilateral and regional trade agreements, as well as unilateral efforts. At the same time, the number of non-tariff measures (NTMs) has risen significantly. Almost half of NTMs in Asia and the Pacific directly address Sustainable Development Goals (SDGs).61 The highest share of SDG-related NTMs directly address Goal 3 (Good Health and Well-being) (see figure III.D.1.1). NTMs that address this Goal include regulation of medicines, food safety, technical regulations on vehicle safety, and regulations on trade, and packaging of alcohol and tobacco products. NTMs that arise due to international agreements (such as the Montreal Protocol on Substances that Deplete the Ozone Layer) and address Goal 12 (Responsible Consumption and Production) are also prevalent, highlighting the need for international collaboration to achieve SDGs. While other Goals are addressed by relatively fewer NTMs, they are nonetheless important for sustainable development. However, the analysis indicates that some SDG targets remain unaddressed by trade regulations. For example, only 10 per cent (approximately) of the economies in Asia and the Pacific have at least one NTM addressing illegal, unreported and unregulated (IUU) fishing and illegal timber trade. As such, there seems to be more scope for Member States of the United Nations in this region to address these aspects of sustainable development through trade measures.

Figure III.D.1.1 Distribution of NTMs that directly address SDGs, by Goal (Share of NTMs that address SDGs in percentage)

Asia-Paci c World 50

0.14 0.07 0.19 0.32 1.32 1.81 0.01 0.02 1.46 1.26 0

Source: Economic and Social Commission for Asia and the Paci c and UNCTAD, Asia-Paci c Trade and Investment Report 2019 (New York, 2019).

NTMs as policy instruments are not inherently good or bad. They often many cases, reducing the cost to traders does not mean outright removal serve important purposes, such as protection of human, animal and plant of NTMs, but rather ensuring that NTMs are coordinated across economies health, or protection of the environment, and can therefore help achieve and that compliance procedures are simplified and digitalized. the 2030 Agenda (box III.D.1). Nonetheless, caution should be exercised to ensure that any such measures do not place an unnecessary burden on compliant traders. 3. The multilateral trading system Furthermore, any regulations must be non-discriminatory in nature, The multilateral trading system overseen by the WTO has contributed meaning both foreign and domestic producers are affected equally. The significantly to the unprecedented economic development that has taken key challenges for policymakers are evaluating whether NTMs are the most place over the last decades. Greater certainty over trade policies creates effective tools for achieving the public policy objectives and, if so, how predictability that allows long-term business planning and investment. to strike the right balance between their positive (intended) effects and The recent erosion of predictability and certainty has made the system’s the cost to traders (and ultimately consumers) associated with them. In value more evident. However, the system is now in jeopardy.

112 INTERNATIONAL TRADE AS AN ENGINE FOR DEVELOPMENT

3.1 Progress on multilateral trade negotiations and WTO Treatment for developing countries. Some members feel that eligibility reform for special and differential treatment should be determined before any negotiations start. Others feel that potential flexibilities, and the extent WTO rules are an important means for pursuing inclusive trade and to which members can use them, should be part of a negotiation. Still economic growth. One of the core principles that underpin the function- others want the present system of self-denomination and undifferentiated ing of the multilateral trading system is that of non-discrimination. The Special and Differential Treatment for developing countries to continue. most-favoured nation and national treatment provisions of the WTO The Trade Facilitation Agreement shows that functional, good-faith solu- prohibit arbitrary discrimination among trading partners and promote tions on Special and Differential Treatment are possible, although other an inclusive approach to the sharing of benefits from government trade templates and alternatives may also be found. concessions. Work has already started in more concretely defining the desired outcomes These benefits should not be taken for granted. For the WTO to keep for the Twelfth WTO Ministerial Conference (MC12), to be held in Kazakh- working and delivering on development goals, the system needs to be stan in 2020. Some long-standing issues, such as agriculture and food supported and strengthened. security, continue to be on the docket as items that need to be addressed. There are several challenges to the system’s ability to keep on functioning Groups of members are also working towards new rules on a range of as it has in the past. These include the marked increase in trade-restrictive issues (e-commerce, investment facilitation, domestic regulation in servic- measures—often referred to as trade wars—and the impasse over the es) that aim to make trade more efficient and predictable in cutting-edge Appellate Body, which is weakening the ability of WTO to resolve trade sectors of the economy. Members are seeking, as well, to make it easier, disputes among members. safer and more viable for women and smaller businesses to participate in To address these challenges, WTO members have already started working global trade. However, some members are of the view that the WTO should on strengthening mechanisms of cooperation and building confidence in finish the work on issues that were mandated at the Doha Ministerial the trading system, through reforms aimed at updating the WTO rulebook Conference before embarking on discussions of other issues. and the ways the organization operates. These efforts for reform cover all Many members are looking towards MC12 as a possible target for deliver- the main functions of the organization. ing some tangible outcomes on reform. In the meantime, some members The first is the dispute settlement and addressing the impasse in the have taken steps to address the most urgent issues. In January 2020, China appointments to the Appellate Body. This is of the utmost importance in and the United States concluded their Phase One trade deal which has preserving the rules-based trading system which protects all WTO mem- resulted in a truce in their trade tensions including some dismantling of bers, and makes sure that the rules remain enforceable. A well-functioning trade barriers that were imposed earlier. dispute settlement mechanism benefits all members that rely on the rule of law to defend their trade interests. 3.2 Treatment of e-commerce in the WTO The dispute settlement mechanism suffered a setback at the end of 2019 A recent WTO study has found that by lowering costs and increasing when members could not agree on reforms for the Appellate Body. Since productivity, digital technologies could provide an additional boost to then, consultations with members have started to identify potential trade by up to 34 per cent by 2030.18 But developing countries may face solutions. At the same time, many members are weighing an array of barriers specific to their circumstances, including disadvantages in terms of creative interim options to keep two-stage dispute settlement operational digital connectivity. while a permanent arrangement is found. In particular, a group of WTO Addressing such barriers requires efforts to promote competition and members agreed in January 2020 to work together to put in place a tran- encourage investment in telecommunications, especially in rural areas and sitional mechanism for appeals of WTO panel reports in disputes among countries most in need. Trade agreements play a role in this. For example: themselves. The General Agreement on Trade in Services (GATS) supports enhanced The second area of focus is on improving the regular work of the WTO Internet access by promoting competitiveness in telecommunications; councils and committees. These bodies monitor how members observe the current rules of the WTO. Several members have insisted on the need to The WTO Information Technology Agreement (ITA) facilitates the diffu- improve transparency among the membership’s trade policies. Clearly, it is sion of technologies around the world through the elimination of tariffs vital that members meet their obligations on transparency and notifica- on a number of IT products, thereby enhancing their affordability. tions—although some members say they need assistance to do so. Over the past few years, there has also been growing interest in discussing The third area of focus is advancing negotiations at the WTO. In the short e-commerce issues in more detail at the WTO. This is happening under term, the key multilateral test is the negotiations on fisheries subsidies. At two tracks: the end of 2019, there was a reset in these negotiations. This is not just a The first is the existing Work Programme on Electronic Commerce, which trade issue; it is a sustainable development issue as well. Failing to suc- was established in 1998 to examine all trade-related issues relating to cessfully conclude these negotiations will not just be bad for marine fish global e-commerce. At the end of 2019, under this Work Programme, WTO stocks, it will also affect the credibility of the WTO and cast doubt on the members agreed to maintain the current practice of not imposing customs feasibility of multilateral rulemaking. duties on electronic transmissions (i.e., online trade of digitalized products Another important issue that has made it to the top of the agenda is the such as e-books and software) until MC12. Since 1998, WTO members have question of who should continue to benefit from Special and Differential periodically renewed the moratorium at each ministerial conference. The 113 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

work in the run-up to MC12 will include structured discussions on issues Among developed economies, the European Union (EU) has formed that would help Ministers take an informed decision. large-scale bilateral free trade agreements (FTAs) with developed-country The second track is the Joint Statement Initiative on Electronic Commerce, partners, which include the Canada-EU Comprehensive Economic and which was launched on the margins of the Eleventh WTO Ministerial Trade Agreement (provisional application started in September 2017) Conference (MC11) in 2017. At MC11, 71 WTO members issued a Joint State- and the EU-Japan Economic Partnership Agreement (entered into force in ment on Electronic Commerce, in which they agreed to initiate exploratory February 2019). The United States renegotiated its existing RTAs, such as work together towards future WTO negotiations on trade-related aspects the US-Korea Free Trade Agreement (September 2018), the US-Mexico- of e-commerce. In January 2019, 76 WTO members issued a second Joint Canada Agreement (previously NAFTA) (USMCA, 30 November 2018), and Statement on Electronic Commerce, in which they confirmed their inten- signed new ones such as the US-Japan Trade Agreement (September 2019). tion to commence negotiations on trade-related aspects of e-commerce. While the United States withdrew from the Trans-Pacific Partnership (TPP) This initiative, which is open to all WTO members, now includes 83 Agreement, it has been revived to become the Comprehensive and Progres- members representing over 90 per cent of global trade. In 2019, six sive Agreement for Trans-Pacific Partnership (CPTPP) by the other original 20 negotiating rounds were held around “streamlined texts” drawn from TPP signatories. The CPTPP entered into force on 30 December 2018. members’ proposals. These negotiations seek to achieve a high standard RTA negotiations have intensified through South-South and South-North outcome that builds on existing WTO agreements and frameworks in order configurations as well. The members of the Association of Southeast Asian to further enhance the benefits of e-commerce for businesses, consumers Nations (ASEAN) along with six regional partners have been negotiating and the global economy. Negotiations will continue in 2020 with the aim the Regional Comprehensive Economic Partnership Agreement (RCEP) since of reaching a consolidated text by MC12. 2012. In November 2019, India suggested it would stay out of RCEP. If India Outside the multilateral trading system, ensuring a truly inclusive digital decided to remain in RCEP, it would create the world’s largest RTA in terms 21 revolution that facilitates the participation of smaller players in the global of population, combined GDP and trade. Meanwhile, the negotiations on economy will require providing support to small business owners to take the African Continental Free Trade Area (AfCFTA) were concluded in March advantage of digital technologies. It also requires tackling complex and 2018. The AfCTA creates a market comprising more than 1.3 billion people 22 sensitive issues, such as privacy, Internet neutrality, consumer protection and a combined national income of $2.5 trillion (see box III.D.2). To and data flows. The lack of clear legal and regulatory frameworks on these facilitate the monitoring of AfCFTA implementation and address data gaps, issues can undermine confidence in online trade and erode consumer trust. the development of the African Trade Observatory was agreed in 2019. The international community beyond the WTO also needs to consider how competition policies can be used to prevent trade gains from becoming dis- Box III.D.2 proportionally captured by dominant players, such as online marketplace African Continental Free Trade Area entering platforms. It is important to ensure not only free but also fair competition operational phase in digital markets, where small firms face challenges in their contractual relationship with big platforms. Competition law provisions on unfair trade The African Continental Free Trade Area (AfCFTA) entered into practices and abuse of superior bargaining position would empower na- force on 30 May 2019, following the deposit of the instrument of tional competition authorities in protecting the interests of smaller firms ratification by the twenty-second African Union member state. The vis-à-vis big businesses. Pro-competition rules and regulations for digital Agreement has been ambitious from the start, with negotiations markets platforms—such as interoperability, data sharing, open stan- launched only in July 2015. In terms of number of members, the dards and data portability for consumers—could promote competition in Agreement is the largest since the establishment of the World Trade these markets.19 There is a clear need for regional and/or international Organization. The AfCFTA is also ambitious in scope: in addition to cooperation and coordination in this area to effectively enforce competi- trade in goods, negotiations have covered trade in services, with tion rules in support of smaller firms. investment, competition policy, and intellectual property rights being tackled in the second phase of the negotiations. It has also been agreed that a third phase of negotiations will be carried out, 4. Bilateral and regional trade and focusing on e-commerce. The liberalization of trade in goods covers 90 per cent of tariff lines investment agreements to be liberalized over 5 years (10 for LDCs), with an additional 7 per Against increasing uncertainties over the multilateral trading system cent of goods indicated as sensitive and subject to a longer transition and heightened trade tensions, countries need to continue deepening period of 10 years (13 years for LDCs). Three per cent of goods can be 62 economic integration by forming new, or strengthening existing, bilateral excluded from liberalization. The Economic Commission for Africa and regional agreements on trade and investment. has estimated that, at this level, the liberalization of trade in goods will increase the value of intra-African trade by 15 to 25 per cent (compared to the baseline scenario of no AfCFTA).63 The share of 4.1 Bilateral and regional trade agreements intra-African trade would also rise, between 40 and 50 per cent com- According to the WTO Regional Trade Agreements Database, 304 regional pared to the start of implementation.64 Most importantly, the free trade agreements (RTAs) are in force as of February 2020, as compared to trade area would largely impact trade in industrial goods, increasing 291 in January 2019.

114 INTERNATIONAL TRADE AS AN ENGINE FOR DEVELOPMENT

nearly as many as in each of the previous three years. As of 1 January its value by 25 to 30 per cent, providing a boost to Africa’s industrial- 2019, the total number of publicly known ISDS claims had reached 942 ization agenda. Substantial additional gains are also expected from (figure III.D.8). liberalization beyond trade in goods. Almost all known ISDS cases have thus far been based on old generation At the time of this writing, the member states are preparing their investment treaties. To date, 117 countries have been respondents to one tariff schedules for trade in goods and the rules of origin, as well as or more ISDS claims. As some arbitrations can be kept confidential, the their commitments on trade in services in the five priority sectors: actual number of disputes filed in 2018 and previous years is likely to be transport, communications, financial services, tourism and busi- higher. Over two thirds of the publicly available arbitral decisions rendered ness services. Implementation is planned to start on 1 July 2020, in 2018 were decided in favour of the investor, either on jurisdictional supported by a dedicated AfCFTA secretariat to be established in grounds or on merits. By the end of the year, 602 ISDS proceedings had Accra. The second phase of the negotiations is also expected to start been concluded. in 2020. The AfCFTA is a centrepiece of Agenda 2063: the Africa We Forward-looking IIA reform is well under way. All treaties concluded Want, agreed in 2013 by the members of the African Union. in 2018 contain several reforms that are in line with either the UNCTAD Reform Package for the International Investment Regime24 or the UNCTAD The Second High-level United Nations Conference on South-South Coopera- Investment Policy Framework for Sustainable Development.25 Modern tion (BAPA+40), held in Buenos Aires in March 2019, also reaffirmed the treaties often include a sustainable development orientation, preserva- importance of strengthening South-South trade cooperation, including tion of regulatory space, and improvements to or omissions of investment through the Global System of Trade Preferences among Developing dispute settlement. The most frequent area of reform is the preservation Countries (GSTP). Established in 1989, the GSTP agreement provides a of regulatory space. Some recent IIAs or treaty models also contain explicit framework for preferential tariff reductions among 43 developing coun- references to gender equality. tries. The São Paulo Round (SPR) of negotiations on GSTP was concluded in Sustainable development orientation. IIAs concluded in 2018 include 2010 but has not yet entered into force. UNCTAD preliminary research finds a large number of provisions explicitly referring to sustainable a welfare gain of $14 billion from the implementation of the SPR by just development issues (including the right to regulate for sustainable 23 eleven signatory countries. development-oriented policy objectives). Of the 29 agreements Recent RTAs aim at deeper economic integration of member countries reviewed, 19 have general exceptions—for example, for the protec- covering issues that are important for the achievement of sustainable tion of human, animal or plant life or health, or the conservation of development in the environmental and social dimensions, particularly exhaustible natural resources. Sixteen recognize that the parties economic empowerment of women (see section 6.2). should not relax health, safety or environmental standards to attract investment. Twenty five of the preambles refer to the protection 4.2 Bilateral and regional investment agreements of health and safety, labour rights, the environment or sustainable development. Finally, corporate social responsibility (CSR) obligations International investment policymaking remains highly dynamic. In 2018, and the inclusion of proactive investment promotion and facilitation 40 new international investment agreements (IIAs) were signed. The new provisions are becoming more prevalent, although they still do not treaties included 30 bilateral investment treaties (BITs) and 10 treaties feature consistently in recent IIAs. This is especially true for CSR provi- with investment provisions (TIPs). The country most active in concluding sions, which appeared in only 13 of the 29 IIAs. IIAs was Turkey with eight BITs, followed by the United Arab Emirates with six BITs and Singapore with five treaties (two BITs and three TIPs). Some Preservation of regulatory space. Treaties concluded in 2018 include el- of the new treaties are megaregional, having novel features and involving ements that aim more broadly than ever at preserving regulatory space key investor countries. The new treaties brought the number of IIAs to and/or minimizing exposure to investment arbitration. The number of 3,317 (2,932 BITs and 385 TIPs). By the end of the year, 2,658 IIAs were in new treaties that incorporate these reforms are substantial. Elements force (figure III.D.7). include (i) general exceptions (19 IIAs); (ii) clauses that limit the treaty scope (e.g., by excluding certain types of assets from the definition of At the same time, the number of IIA terminations continued to rise. In 2018, investment (27IIAs)); (iii) clauses that limit or clarify obligations (e.g., at least 24 terminations entered into effect (“effective terminations”), 20 of by omitting or including more detailed clauses on fair and equitable which were unilateral and 4 of which were due to replacements (through treatment (FET) (all 29 IIAs) and/or indirect expropriation (23 IIAs)); the entry into force of a newer treaty). This included 12 BITs terminated by and (iv) clauses that contain exceptions to transfer-of-funds obliga- Ecuador and 5 by India. By the end of the year, the total number of effec- tions and/or carve-outs for prudential measures (all 29 IIAs). Notably, tive terminations reached 309 (61 per cent having occurred since 2010). 28 of the 29 treaties omit the so-called umbrella clause (thus also Many countries are developing new model treaties and guiding principles narrowing the range of possible ISDS claims). to shape future treaty making. This will have a significant impact on the Investor-State arbitration. Investor-State arbitration is also a central global IIA regime. Many of these developments have benefited from the focus of IIA reform.26 It continues to be controversial, spurring debate work of UNCTAD on IIA-related technical assistance and capacity-building. in the investment and development community and the public at The surge in investor-state dispute settlement (ISDS) cases continues. In large. About 75 per cent of IIAs concluded in 2018 contain at least one 2018, investors initiated 71 publicly known ISDS cases pursuant to IIAs, ISDS reform element, and many contain several. Most of the reform

115 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Figure III.D.7 Number of IIAs signed, 1980−2018 (Annual number of IIAs)

BITS TIPS 250

Number of IIAs 200 in force 2 658

150

100

0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Source: UNCTAD, World Investment Report 2019, based on UNCTAD IIA Navigator.a a Comprehensive, user-friendly and free of charge database, UNCTAD International Investment Agreements Navigator. Available at https://investmentpolicy.unctad.org/international-investment-agreements/.

Figure III.D.8 Trends in known treaty-based ISDS cases, 1987−2018 (Annual number of cases)

International Centre for Settlement of Investment Disputes (ICSID) Non-ICSID 100

Cumulative number 80 of known ISDS cases 942

0 1987 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Source: UNCTAD, World Investment Report 2019, based on UNCTAD ISDS Navigator.a a Ibid.

116 INTERNATIONAL TRADE AS AN ENGINE FOR DEVELOPMENT

elements related to ISDS are in line with the options identified by process, and lack of profitability for banks. The survey is rather pessimistic UNCTAD in the Investment Policy Framework for Sustainable Develop- about short-term prospects for reducing trade finance gaps: 60 per cent of ment. Five principal approaches emerge from IIAs signed in 2018 (used respondent banks expect the global trade finance gap to increase in the alone or in combination): (i) no ISDS (4 IIAs entirely omit ISDS); (ii) a next two years. standing ISDS tribunal (1 IIA); (iii) limited ISDS (19 IIAs); (iv) improved Trade finance gaps have been compounded by the decline in corre- ISDS procedures (15 IIAs); and (v) an unreformed ISDS mechanism spondent banking. Following the global financial crisis in 2008-2009, (6 IIAs). Some of the reform approaches have more far-reaching about 20 per cent of the correspondent banking relationships have implications than others. ISDS reform is being pursued across various disappeared, with Africa, the Caribbean, Central and Eastern Europe and regions and by countries at different levels of development. In parallel, the Pacific Islands the most affected regions. Such declines negatively multilateral engagement on ISDS reform is gaining prominence, involv- impact trade finance since local banks need international correspondent ing several institutions such as UNCITRAL and the International Centre banks to confirm their letters of credit, engage with them in supply for Settlement of Investment Disputes. chain finance, and clear trade-related payments in foreign currency. The But comprehensive reform is only just beginning. IIA reform is progressing, adoption of new anti-money-laundering and countering the financ- but much remains to be done. UNCTAD policy tools, including the Reform ing of terrorism (AML/CFT) regulations have increased the cost and Package for the Global Investment Regime, have spurred initial action the perceived risk of operating in some developing countries, and led to modernize old generation treaties. Increasingly, countries interpret, some international banks to terminate their correspondent banking amend, replace or terminate outdated treaties. However, the stock of relationships.29 To help address these risks, the ADB “scorecard” project old generation treaties is 10 times larger than the number of modern, has aimed at developing trade finance tools such as the joint “suspicious reform-oriented treaties. activity report”. IIA reform actions are also creating new challenges. New treaties aim The complexity of trade finance also results from the continuous use of to improve balance and flexibility, but they also make the IIA regime paper-intensive products, such as paper letters of credit. Digitalization can less homogenous. Moreover, innovative clauses in new treaties have help reduce the operational costs for trade finance providers. By reducing not yet been tested in arbitral proceedings. Different approaches to ISDS the need for multiple record-keeping infrastructures, technology solutions, reform—ranging from traditional ad hoc tribunals to a standing court, or such as distributed ledgers, can also increase market transparency and to no ISDS—add to broader systemic complexity. Moreover, reform efforts decrease the need for verification and reconciliation of multiple records are occurring in parallel and often in isolation. Effectively harnessing held by different intermediaries (see chapter III.G). In several test-cases, international investment relations for the pursuit of sustainable develop- processing times have been reduced from more than a week to just a few ment requires holistic and synchronized reform through an inclusive and hours.30 At present, these successful pilot cases involve proprietary and transparent process that can be supported by the United Nations system. limited closed-loop solutions among small groups of certified partners. In order to implement such technologies at a global scale, there will be a need for harmonized standards and interoperability between different 5. Facilitating international trade systems. Capacity development for financial institutions in developing countries will also be needed to increase digitalization. To date, these 5.1 Trade finance gaps and instruments institutions have been slow to adopt new technologies, with those actors surveyed complaining about the high cost and the lack of global standards Access to affordable trade finance is a condition for successful international for digital finance (lack of “interoperability” of digital platforms). trade, similar to rapid clearance of customs and efficient transportation. Without access to trade finance, many entrepreneurs cannot trade and Given the large gaps in commercial trade finance for SMEs, especially in the compete. Yet, the lack of local access to trade finance was cited as an poorest countries, MDBs are an important source of trade finance in devel- obstacle to economic diversification by 60 developing WTO members and oping countries, under so-called trade finance facilitation programmes. For by 14 donor respondents in a recent survey.27 example, in the last two years, ADB doubled the number of trade transactions it supported involving SMEs, with 3,500 SMEs supported in 2018. Trade finance is normally a high-volume and low-cost source of finance. The risk of default is small, with a global average of 0.2 per cent, and with Capacity-building is key to helping local banks comply with new financial little difference across countries. However, underdeveloped financial regulations, as well as for adopting new technologies. The WTO, Interna- sectors in some countries have not been able to provide sufficient and tional Finance Corporation, and Financial Stability Board (FSB) are working affordable trade finance services. together to inform trade finance providers about relevant regulatory requirements, promote tools to make compliance more effective and less As a result, there are significant gaps between supply and demand, costly for local banks, and help them attract new correspondents.31 For estimated at $1.5 trillion in 2018 (stable compared to 2017) in an example, the WTO and FSB have been encouraging the development of industry survey led by the Asian Development Bank (ADB).28 SMEs are synergies between legal identifiers provided by the Global Legal Entity particularly affected, since 45 per cent of their trade finance proposals Identifier Foundation and the World Customs Organization. were rejected by surveyed banks. Half of the rejected SMEs abandoned trade transactions, as they were unable to find appropriate alternative Country diagnoses are necessary if capacity-building and country advice financing. Rejections are explained by a variety of factors, including lack are to be well targeted and effective. WTO currently examines the pos- of collateral, lack of proper information available during the application sibility of more systematically integrating trade finance in diagnostic trade 117 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

integration studies of the Enhanced Integrated Framework, which is a implementation. An estimated 64.7 per cent of notifiable commitments multilateral partnership dedicated to assisting LDCs. are being implemented, based on members’ notifications to the WTO Trade Facilitation Committee (TFC) (see also box III.D.3 for updates on the 5.2 Aid for trade implementation of trade facilitation measures). SDG target 8.a calls for increased Aid for Trade support for developing In addition to those members that are already implementing the TFA in countries, particularly LDCs. The objective of the Aid for Trade initiative is full, all developing countries now have roadmaps for the implementation to help these countries build the supply-side capacity and trade-related of the Agreement. These members had to notify the committee of their infrastructure they need to implement and benefit from WTO agreements, individual plans for full implementation of the TFA, based on the unique and to expand their trade. flexibilities provided by the Agreement, by August 2019. In 2017, the most recent year for which data is available, global disburse- To support developing-country implementation efforts, the WTO has ments of Aid for Trade reached $43.1 billion. This represents a yearly established the Trade Facilitation Agreement Facility (TFAF), funded increase of $4.2 billion (11 per cent) compared to 2016, and $25.8 billion by WTO members on a voluntary basis. Its main goals are to assist (136 per cent) compared to the 2006 baseline recorded following launch developing-country and LDC members in submitting notifications to the of the Aid for Trade initiative. Commitments have also been on a steady in- WTO Trade Facilitation Committee in a timely fashion, and to establish crease. Overall, global Aid for Trade disbursed in 2006-2017 has amounted and reinforce national trade facilitation committees to coordinate to an overall $409 billion, 27 per cent ($108.5 billion) has gone to LDCs. implementation of the Agreement. For example, TFAF supported WTO developing-country and LDC members to submit a total of more than fifty The Seventh Global Review of Aid for Trade was organized in 2019 by the notifications to the WTO TFC within six weeks of the respective TFAF event. WTO on the theme “Supporting Economic Diversification and Empower- ment”. The report underpinning the review highlights the continuing centrality of economic and export diversification as a policy objective among developing countries, and the role that economic empowerment 6. Promoting international trade can play to facilitate this process as well as benefit from it.32 The Aid for Trade new work programme for 2020-2021 will address the theme of that is consistent with the Sustainable “Empowering connected, sustainable trade”. Development Goals in an era of 5.3 Trade facilitation disruptive technologies Since the entry into force of the WTO Trade Facilitation Agreement (TFA) To fully reap the benefits of trade, countries must mainstream trade into on 22 February 2017, 148 of 164 WTO members, representing 90 per cent, their national sustainable development strategies and integrated national have ratified the TFA. Significant progress has also been achieved in its financing frameworks. This is because trade has cross-cutting effects in

Figure III.D.9 Aid for Trade disbursements and commitments (Billions of United States dollars)

0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Commitments Disbursements

Source: OECD Aid for Trade Database.

118 INTERNATIONAL TRADE AS AN ENGINE FOR DEVELOPMENT

Box III.D.3 United Nations Global Survey on Digital and Sustainable Trade Facilitation: 2019 Results The United Nations Global Survey on Digital and Sustainable Trade Facilitation, conducted jointly by the five United Nations Regional Commissions with the support of a wide range of global and regional partners, provides a comprehensive picture of the state of implementation of trade facilitation and paperless trade. The most recent Survey was conducted in 2019 and covers 128 economies. The Survey’s scope is not limited to World Trade Organization (WTO) Trade Facilitation Agreement (TFA) provisions but also includes many TFA+ measures, including Digital trade facilitation measures to enable the use and exchange of electronic trade data and documents; and Sustainable trade facilitation measures specifically targeted at small and medium-sized enterprises (SMEs), the agricultural sector and women. As shown in the figure below, the global average implementation of an ambitious and forward-looking subset of the WTO TFA+ measures included in the Survey stands at 62.7 per cent. Implementation in sub-Saharan Africa, which includes some of the poorest countries in the world, is only 47.8 per cent, second only to the Pacific Islands. Countries with special needs (least developed economies, landlocked developing countries and small island developing States) achieve implementation rates ranging between 43 and 55 per cent, which is significantly below the global average implementation rate.

Figure III.D.3.1 Trade facilitation implementation around the world between 2017 and 2019 (Percentage)

2017 2019 80

0 Developed Latin America Middle East Paci c South and South Asia South-East Sub-Saharan Least Landlocked Small island Global Economies and the and Islands East Europe, and Africa developed developing developing average Caribbean North Africa Caucasus East Asia countries countries states and Central Asia (LCDs) (LLDCs) (SIDS)

Source: UNCTAD, World Investment Report 2019, based on UNCTAD ISDS Navigator.

Progress has been made in essentially all the countries covered by the Survey between 2017 and 2019. Implementation at the global level has, on average, increased by approximately 6 percentage points over the last two years. The survey reveals that countries have made particularly good progress on implementing TFA measures—for example, transparency measures such as publishing regulations on the Internet or organizing consultations prior to issuing new regulations. Many countries have also started to implement paperless trade measures, including development of electronic single window facilities. However, little attention has been given so far to implementation targeted at women and SMEs. In addition, cross-border paperless trade (i.e. the exchange of electronic trade data and documents across borders) remains essentially at the pilot stage, often limited to bilateral exchange of a specific document. Accelerating progress in this area could help reduce trade costs significantly, but requires more intensive intergovernmental cooperation. Recognizing this, members of the Economic and Social Commission for Asia and the Pacific (ESCAP) have adopted a Framework Agreement on Facilitation of Cross-Border Paperless Trade in Asia and the Pacific, aimed at building capacity and cooperation on paperless trade.

Source: United Nations Global Survey on Digital and Sustainable Trade Facilitation 2019. Available at https://untfsurvey.org/.

119 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

the economy and significant linkages to other sectors. Mainstreaming 6.2 Women as producers and traders trade policies into development plans enhances coherence in the use of Trade policy influences economic empowerment of women as producers trade as a proactive tool in achieving poverty reduction and economic or consumers through, inter alia, impacts on wages and price changes for transformation. consumption products.38 6.1 Impact of technological changes on global value chains UNCTAD examined key differences and similarities of the trade and gender nexus in the context of two regional trade liberalization entities: Technological change, such as digitalization, is opening new channels for the East African Community (EAC) and the Southern Common Market value addition and can ignite broader structural change in the organiza- (MERCOSUR).39 Despite differences in terms of the stages of develop- tion of global value chains (GVCs). Emerging digital technologies such as ment, extent of gender inequalities, and legal frameworks on gender blockchain, three-dimensional (3D) printing, automation and robotics, and equality, the trade and gender implications of regional integration artificial intelligence all suggest the growing importance of data analytics. are very similar across the two regions.40 In both regions, the process Digital technologies also reduce trade costs, and this is likely to be a push of regional integration has been accompanied by a shift of sectoral factor for GVCs. Most importantly, digital technologies make more services employment structures towards the services sector, which absorbs the tradeable by reducing the need for face-to-face interaction in services largest share of total female employment, particularly in MERCOSUR. trade. This creates opportunities for services providers, such as micro, small However, in services, women are segregated in lower-skilled ser- and medium enterprises operating from their home base, to participate in vices sectors. GVCs. There is a large scope for smaller firms and for developing countries As regards the manufacturing sector, regional tariff liberalization contrib- to grab the opportunities that trade in services provides.33 uted towards a feminization of labour: it increased the female employment Digitalization also increases the importance of data flows. In virtually every share in manufacturing firms, but mainly for workers involved in basic value chain, the ability to collect, store, analyse and transform data brings tasks. There was little change for those in charge of more managerial re- added power and competitive advantages. Digitalization and datafication sponsibilities. This could be explained by the fact that the gender wage gap affect the way GVCs are governed. Lead firms in GVCs are adopting busi- makes female workers a source of competitive advantage for exporting ness models that increasingly rely on data, facilitated by digital technology firms; hence the demand for their labour tends to rise in the unskilled and that provides new methods for value chain management. As a result of labour-intensive modes of production. Another reason for this may be that datafication of GVC management, value is increasingly captured by lead trade-induced technological upgrading reduces the need for physically firms that control the data, while firms in the manufacturing and assembly demanding skills, in turn improving employment opportunities for women segments become interchangeable. relative to men. From a geographical perspective of the emerging global data value chain, In order to enable women to receive quality employment opportunities most countries are data suppliers. Lead multinational corporations receive from trade liberalization, it is imperative that trade policy changes be most of the data and can turn them into digital intelligence that can be systematically assessed from a gender perspective, with special attention monetized and used to generate value-added data products (see also given to social norms that tend to associate women with secondary roles chapter II and its box II.4 on the data economy). From the perspective of in the labour market. In this regard, trade policy changes need to be ac- the global data economy, the work being done in developing economies companied by measures in support of economic empowerment of women, other than China is typically of low value. The consequence of these such as promoting access to vocational training and skill certification dynamics is that, instead of latecomer economies catching up in the data programmes. economy, their subordinate status may get accentuated. The risk is that A review of trade policies of 111 WTO members from 2014 to 2018 shows most countries, and particularly LDCs, will become exporters of raw data that most members (about 70 per cent) have integrated women’s empow- and importers of value-added data products, with little domestic ability to erment in their national or regional trade strategy in order to enhance potentially change this status.34 women’s workforce participation;41 for example, some strategies aim at Further, certain new technologies are reducing the rationale of GVCs itself, promoting female employment and access to male-dominated economic such as 3D printing that makes the geographical relocation of tasks redun- sectors. While most countries establish general gender objectives in their dant. This can disrupt international trade in goods while boosting trade in trade policies, some measures can also be very specific. These include designs. Automation and robotics technology also significantly influence financial and non-financial incentives in support of women-owned/led the future of GVCs, as it reduces the comparative advantage developing companies, training programmes for women farmers and fisherwomen, countries have due to cheaper labour costs. The technology allows lead and preference in government procurement to companies that implement firms in developed countries to “reshore” the manufacturing and assembly gender-equality or wage-equality policies. segments.35 In 2018, global sales of industrial robots (those used mainly Digital technologies can also foster the upward mobility of women beyond in the automotive, electrical/electronic and metal industries) doubled the informal sector and subsistence levels. For example, the rapid uptake between 2013 and 2017. This trend seems set to continue.36 and expansion in Africa of mobile finance applications, such as mobile Yet, there is still no conclusive evidence that GVCs are receding for the time money, is strengthening the potential for a wider variety of alternative being; for instance, GVCs appear to have remained stable for electronics financing and insurance schemes available to women entrepreneurs (see where they are well developed.37 The impact might thus differ depending chapter III.B). Leveraging new networks of women leaders in e-commerce on the sectors. in different developing regions can also give women leaders more visibility 120 INTERNATIONAL TRADE AS AN ENGINE FOR DEVELOPMENT as role models and provide them with opportunities to influence the Considering the issue of more equitable share of trade gains to all types of policy debate at national and international levels.42 Online platforms workers, there is evidence that including labour rights in trade agreements can also be used to showcase businesses from women entrepreneurs and will benefit workers in developing countries;48 investment in educa- help companies to include more women-owned/led businesses in their tion and training of poor households is another means. With regard to supply chains. For example, the International Trade Commission SheTrades providing equal opportunities to firms: e-commerce, ICT services, export initiative aims to connect 3 million women entrepreneurs to international promotion initiatives, and promoting the inclusion of technical assistance markets by 2021.43 and Aid for Trade programmes in bilateral and regional agreements all have great potential for levelling the playing field between small and large 6.3 Trade, jobs and inequality firms in accessing global markets. Trade policy should also provide equal opportunities to all countries. A Trade reforms have contributed to reducing income inequality between key policy issue is safeguarding the open, transparent and predictable countries as well as significantly reducing poverty. Trade can also have a multilateral trading system (target 10 of SDG 17). It is also important, inter pro-poor bias within countries by disproportionately reducing the prices alia, to (i) ensure that any reform process is inclusive of lower-income faced by poorer households.44 More generally, it is important to note that countries through, inter alia, updating and modernizing special and trade is not a main factor behind increased inequality within countries,45 differential treatment (SDG targets 10.A, 17.11 and 17.12); and (ii) provide as technological change has played a key role.46 At the same time, the meaningful market access opportunities that address tariff escalation and reallocation of resources necessary to reap the benefits from trade can also trade-distorting subsidies in agriculture. have adverse consequences. When reallocation is costly, adverse effects on certain individuals and communities can be large and long-lasting if not addressed properly and promptly. 6.4 Addressing challenges related to illegal wildlife trade Resorting to protectionism to improve distribution of benefits from trade is and illegal unreported and unregulated fishing not a solution, as it would only reduce the overall amount of gains. Trade is While legal, sustainable, and traceable trade in wildlife can have great a catalyst for economic growth and development as recognized in the SDGs. benefits in terms of conservation and sustainable development, illegal Accordingly, policies, including trade promotion, should not only pursue ef- trade in wildlife undermines conservation efforts and has devastating ficiency gains but also aim to help small firms and producers, marginalized economic, social and environmental impacts. Illegal wildlife trade is a workers, and women and youth in poorer countries to receive gains from big business, often run by international criminal networks that traffic participating in international and/or regional trade.47 Governments also wildlife and animal parts much like illegal drugs and arms. By its very need to implement adjustment policies to make sure that economic gains nature, it is extremely difficult to obtain reliable figures for the volume and are spread more evenly and that workers affected by job displacement are value of illegal wildlife trade. Data collected through the Convention on supported—for instance through labour-market policies (e.g., job training International Trade in Endangered Species of Wild Fauna and Flora (CITES) and income support). currently amounts to roughly 42,500 seizure records covering the period

Box III.D.4 Gender in bilateral and regional trade agreements A number of regional trade agreements (RTAs), especially those negotiated in recent years, include provisions explicitly referring to gender or gender-related issues. These gender-related provisions are highly heterogeneous and differ in terms of their language, scope and location in the RTA and in their commitments. In most cases, gender provisions in RTAs aim to increase cooperation between the RTA partners to improve training and entrepreneurship or ensure gender equality in the workplace. More extensive provisions on trade and gender have appeared in recent RTAs, including trade and gender sections or chapters. The trade and gender chapters in RTAs increase the visibility of gender issues within trade instruments, reflecting the views that trade policy can be used to foster gender equality and women’s economic empowerment. Such chapters, however, still represent a small first step forward. They do not set specific gender-related goals or standards to comply with, do not require the harmonization of legislation on gender equality between the parties, and, for the most part, are not subject to dispute settlement under the agreement. Other RTAs are conducting ex ante assessments of their potential impact on women and formulate the provisions of the agreement according to the results of the assessment, with a view to making trade agreements more gender responsive. In March 2018, negotiations started between Canada and the four members of Mercosur (Argentina, Brazil, Paraguay and Uruguay) for a possible FTA. Canada conducted a gender-based analysis called GBA+ to assess how the benefits and opportunities resulting from the FTA would be shared among different groups of women, men and non-binary people.65 The GBA+ approach is to assess the likely impact of the FTA on women and other disadvantaged groups, then to formulate provisions that address the identified shortcomings. For example, findings from GBA+ reveals the presence of discrimination in the workplace in the form of gender wage gap; discrimination based on sexual orientation and gender identity; and gender-based harassment, bullying and violence. These shortcomings could be addressed through provisions in the Labour Chapter of the Agreement. As the FTA between Canada and MERCOSUR is under negotiation, the final text will be the result of the views and priorities of all negotiating parties.

121 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

2013-2018, involving about 1,900 species in various product formats, from Assembly declared IUU fishing as one of the biggest threats to sustaining live animals to medicinal products containing animal parts.49 According fish stocks globally.55 IUU fishing causes significant losses of resources, to the World Bank, estimates for the value of illegal wildlife trade run income, jobs and livelihoods. As an example, estimates indicate that West between $5 billion and $23 billion per year.50 Africa loses more than $1.3 billion a year due to IUU fishing.56 The serious nature of wildlife crime is well recognized and reflected in There are global regulatory tools such as the FAO International Plan of many documents adopted at the highest levels in many different forums. Action, the Global Record of Fishing Vessels, and the Agreement on Port The SDGs specifically address tackling illegal trade in wildlife through specif- State Measures to combat and deter IUU fishing.57 Nevertheless, most ic targets under Goal 15, and the first ever United Nations General Assembly developing countries, and particularly LDCs and small island developing resolution adopted in 2015 on this issue calls for firm and strengthened States lack the capacities or the resources to set effective fish management national measures and an enhanced regional and global response.51 The systems and mechanisms to enforce anti-IUU tools and regulations. The subsequent General Assembly resolution adopted in 2017 reinforces the most sensible action is to transfer resources from harmful fisheries sub- focus on key areas in the fight against illicit trafficking in wildlife, and places sidies to management activities. According to the World Bank, investing strong emphasis on the role of CITES and the importance of implementing in fish stocks management will increase global gains by $83 billion.58 In the decisions and resolutions adopted by its governing bodies.52 June 2019, three United Nations agencies—FAO, UNCTAD and the United Nations Environment Programme—proposed an Inter-Agency Plan of Regarding illegal, unreported and unregulated (IUU) fishing, this issue is Action to support the implementation of several SDG 14 targets, such as addressed in the SDGs through targets under Goal 14. According to the 14.4 (restoring fish stock through regulating overfishing and IUU fishing) Food and Agriculture Organization (FAO), about 33 per cent of fish stocks and 14.6 (eliminating fisheries subsidies contributing to IUU fishing), in today have reached overfished status. Overfishing is the consequence of selected developing countries over the next 5 years.59 An essential increasing commercial interest on targeted species and enlarged fishing requirement for an effective management of fish resources is the timely capacity of contemporary fishing fleets. This is exacerbated by IUU fishing acquisition of information on stocks and catches and the exchange of such and harmful subsidies. IUU fishing across the world’s oceans is estimated to information between stakeholders. The United Nations Economic Commis- catch about 11 million to 26 million tonnes of fish annually, with a value of sion for Europe, through its United Nations Centre for Trade Facilitation and $26 billion to $35 billion.53 This suggests that in each 5 dollars of globally e-Business (UN/CEFACT), has developed a global data exchange standard, traded seafood, 1 dollar could be of illegal origin. which helps improve fisheries information management, thus contributing IUU fishing has detrimental impacts not only on global fisheries but also to the prevention of overfishing and the collapse of global fish stocks.60 on marine biodiversity and ecosystems, in addition to its criminal, labour A prohibition on subsidies to IUU fishing is also being discussed in the rights violations, and human rights abuse aspects.54 In 2014, the General context of WTO Fisheries Subsidies negotiations.

Endnotes 1 Key statistics and trends in international trade 2018 (United Nations publication, Sales No. E.19.II.D.5). 2 UNCTAD, “Coronavirus outbreak has cost global value chains $50 billion in exports” (Geneva: UNCTAD, 4 March 2020). 3 Calculation based on the UNCTAD Free Market Commodity Price Index (FMCPI).Available at https://unctadstat.unctad.org/EN/. 4 For example, the monthly average spot price of Brent crude oil increased by 20.1 per cent from January 2019 to $71.2 per barrel in April 2019, before falling back to $59.3 per barrel in August 2019. 5 Digital Economy Report 2019 (United Nations publication, Sales No. E.19.II.D.17). 6 Ibid. 7 UNCTAD, “Global e-commerce sales surged to $29 trillion” (29 March 2019). 8 UNCTAD, Rapid eTrade Readiness Assessments of Least Developed Countries: Policy Impact and Way Forward (Geneva: UNCTAD, 2019). 9 Commodities and Development Report 2017: Commodities Markets, Economic Growth and Development (United Nations publication, Sales No. E.17.II.D.1). 10 State of Commodity Dependence 2019 (United Nations publication, Sales No. E.19.II.D.8). 11 Least Developed Countries Report 2019: The present and future of external development finance – Old Dependence, New Challenges (United Nations publication, Sales No. E.20.II.D.2). 12 This is based on the University of Notre Dame’s Global Adaptation Initiative (ND-GAIN) Index. 13 Commodities and Development Report 2019: Commodity Dependence, Climate Change and the Paris Agreement (United Nations publication, Sales no. E.19.II.D.18).

122 INTERNATIONAL TRADE AS AN ENGINE FOR DEVELOPMENT

14 The product concentration index shows to which degree exports and imports of individual economies or of groups of economies are concentrated on a few products rather than being distributed in a more homogeneous manner among several products. The diversification index indicates to what extent the structure of exports or imports by product of a given economy or group of economies differs from the world pattern (UNCTADStats on Product Concentration and Diversification Indices). 15 The ITC NTM Business surveys series covers already 75 countries across the World, for more information, see https://ntmsurvey.intracen.org/home. 16 Find out more and get in touch: www.standardsfacility.org / [email protected]. 17 UNCTAD, “Non-Tariff Measures: Economic Assessment and Policy Options for Development” (Geneva: UNCTAD, 2017). 18 WTO, World Trade Report 2018: The future of world trade: How digital technologies are transforming global commerce (Geneva, WTO, 2018). 19 Ebru Gökçe Dessemond, “Restoring competition in “winner-took-all” digital platform market,” UNCTAD Research Paper (Geneva: UNCTAD, December 2019). 20 The member countries of the CPTPP are Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, and Vietnam. The CPTPP entered into force for first six countries that ratified the agreement, which were Canada, Australia, Japan, Mexico, New Zealand, and Singapore, then for Vietnam on 14 January 2019. 21 At the ASEAN+3 Summit on 4 November 2019, India announced that it would opt out of RCEP. The other RCEP members suggest they would work to resolve “outstanding issues” with India. 22 UNECA, “African Continental Free Trade Area - Questions & Answers.” Available at https://www.uneca.org/publications/ african-continental-free-trade-area-questions-answers 23 UNCTAD, “Energizing South-South trade: The Global System of Trade Preferences among Developing Countries,” Policy Brief (Geneva: UNCTAD, June 2019). 24 UNCTAD, “UNCTAD’s Reform Package for the International Investment Regime” (Geneva: UNCTAD, 2018). 25 UNCTAD, “Investment Policy Framework for Sustainable Development” (Geneva: UNCTAD, July 2015). 26 UNCTAD, “Reforming investment dispute settlement: A stocktaking,” IIA Issues Note (New York and Geneva: UNCTAD, March 2019). 27 The survey was part of the OECD-WTO monitoring and evaluation exercise conducted in preparation to the 2019 Aid for Trade Global Review. 28 Kijin Kim, Steven Beck and others, ADB Briefs: 2019 Trade Finance Gaps, Growth, and Jobs Survey (Manila, Asian Development Bank, September 2019). 29 IFC and WTO, Trade finance and the compliance challenge: A showcase of international cooperation (Washington, D.C. and Geneva, IFC and WTO, 2019). 30 Naoko Nemoto and Naoyuki Yoshino (eds.), Fintech for Asian SMEs (Tokyo, Asian Development Bank, 2019); Chad Bray, “HSBC Says Blockchain Could Ease Small Firms’ Financing Woes, with Greater Bay Area Key to Success,” South China Morning Post (3 September 2019); and World Economic Forum, “Trade Tech – a New Age for Trade and Supply Chain Finance,” White Paper (Geneva: World Economic Forum, September 2018). 31 IFC and WTO, Trade finance and the compliance challenge: A showcase of international cooperation (Washington, D.C. and Geneva, IFC and WTO, 2019). 32 OECD/WTO, Aid for Trade at a Glance 2019: Economic Diversification and Empowerment (Paris, OECD Publishing, 2019). 33 WTO, World Trade Report 2019: The future of services trade (Geneva, WTO, 2019). 34 Digital Economy Report 2019 (United Nations publication, Sales No. E.19.II.D.17). 35 Trade and Development Report 2017: Beyond Austerity: Towards a Global New Deal (United Nations publication, Sales No: E.17.II.D.5). 36 International Federation of Robotics, World Robotics Industrial Robotics 2019 (Frankfurt, IFR, 2019). 37 Guillaume Gaulier, Aude Sztulman, and Deniz Ünal, “Are Global Value Chains Receding? The Jury Is Still Out. Key Findings from the Analysis of Deflated World Trade in Parts and Components,” Working Paper (Paris: CEPII, January 2019). 38 UNCTAD, “The new way of addressing gender equality issues in trade agreements: Is it a true revolution?” Policy Brief (Geneva: UNCTAD, October 2017). 39 UNCTAD, “Reforming investment dispute settlement: A stocktaking,” IIA Issues Note (New York and Geneva: UNCTAD, March 2019). 40 With respect to gender mainstreaming in trade policy, the EAC treated gender issues as part of its regional integration process in the founding treaty and through the 2017 East African Gender Equality and Development Bill. MERCOSUR, on the other hand, did not have gender provisions in its foundational treaties; gender mainstreaming in regional integration polices was mainly driven by the mobilization of civil society groups, especially women’s organizations. 41 Anoush der Boghossian, “Trade policies supporting women’s economic empowerment: Trends in WTO members,” WTO Staff Working Paper ERSD-2019- 07 (April 2019). 42 To this end, UNCTAD has launched a new eTrade for Women initiative. 43 The ITC SheTrade Initiative works closely with over 350 institutions and stakeholders across the globe, with a database of over 1.5 million women entrepreneurs. The initiative has leveraged technology to close the gender gap by connecting women entrepreneurs and trade partners on an online platform, SheTrades.com, which has currently 25,000 of users from 90 countries. 44 Pablo Fajgelbaum and Amit Khandelwal, “Measuring the Unequal Gains from Trade,” The Quarterly Journal of Economics, Volume 131, Issue 3 (August 2016), Pages 1113–1180.

123 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

45 WTO, World Trade Report 2017: Trade, technology and jobs (Geneva, WTO, 2017). 46 Elhanan Helpman, “Globalization and Wage Inequality,” NBER Working Paper No. w22944 (December 2016). 47 See for example: ITC, “Turning export potential into employment. A case study for Jordan” (December 2018). 48 Trade Policy for Combating Inequality (United Nations publication, Sales No: E.19.II.D.21). 49 CITES, “Annual illegal trade report data storage and databased management,” CoP18 Inf. 44 (August 2019). 50 World Bank and Global Wildlife Program, “Illegal logging, fishing, and wildlife trade: the costs and how to combat it” (October 2019). 51 United Nations, document A/RES/69/314. 52 United Nations, document A/71/L.88. 53 FAO, The State of World Fisheries and Aquaculture 2016: Contributing to food security and nutrition for all (Rome, 2016). 54 UNCTAD, Trade and Environment Review 2016: Fish Trade (United Nations publication); OECD, “Combatting Illegal, Unreported and Unregulated Fishing: Where countries stand and where efforts should concentrate in the future” (November 2018). 55 United Nations General Assembly Resolution A/RES/69/109. 56 Africa Progress Panel, Africa Progress Report 2014: Grain Fish Money - Financing Africa’s Green and Blue Revolutions (Geneva, Africa Progress Panel, 2014). 57 Regulatory measures such as catch documentation, fishing vessel monitoring (VSM), traceability, electronic logging, GPS location and block chains systems for fishers and seafood producers as well as more traditional ones such as observers and on-board and port inspections are also useful tools implemented at national, regional and international levels to combat IUU fishing. 58 World Bank, The Sunken Billions Revisited: Progress and Challenges in Global Marine Fisheries (Washington, D.C., 2017). 59 UNCTAD, “Towards an inter-agency Plan of Action for achieving the trade-related targets of sustainable Development Goal 14.” Available at https:// unctad.org/en/pages/MeetingDetails.aspx?meetingid=2169. 60 UNECE, “Team of Specialists on Sustainable Fisheries.” Available at http://www.unece.org/tradewelcome/un-centre-for-trade-facilitation-and- e-business-uncefact/about-us/team-of-specialists-on-sustainable-fisheries.html. 61 Asia-Pacific Trade and Investment Report 2019: Navigating Non-tariff Measures towards Sustainable Development (United Nations publication, Sales No. E.19.II.F.14). 62 To ensure meaningful liberalization, 90 per cent of import value have to be classified as non-sensitive. 63 By 2040, comparing to a scenario where no AfCFTA is in place. See ECA (2018). African Continental Free Trade Area: Towards the finalization of Modali- ties on Goods. 64 Assumed in 2020. 65 Global Affairs Canada, “Summary of Initial Gender-based Analysis Plus for Canada-Mercosur Free Trade Negotiations” (Ottawa: Global Affairs Canada, 2019).

124

Infographic Goes Here DEBT AND DEBT SUSTAINABILITY Chapter III.E

Debt and debt sustainability 1. Key messages and recommendations

The debt of developing countries continued to rise in while containing debt vulnerabilities. But the fundamental 2019—albeit at a slower pace—and, with it, the risks to debt tension will likely remain in many, if not most, developing sustainability. Forty-four per cent of low-income and least economies, especially those with high debt burdens. Debt developed countries (LDCs) are currently assessed as being at swaps—such as the Economic Commission for Latin American high risk of external debt distress or already in debt distress. and the Caribbean (ECLAC) proposal to swap some of the COVID-19 and related global economic and commodity price Caribbean’s external debt for annual payments into a resilience shocks could significantly increase this number. For example, fund—can be a source of funding for additional SDG invest- several African countries reliant on oil exports could find ments. Piloting of the ECLAC and similar initiatives should be themselves in debt distress. considered. As noted in chapter I, the long period of unusually low interna- Debt sustainability also depends on the effective use of bor- tional interest rates and unprecedented levels of global liquidity rowed resources. There is merit to exploring options that better associated with quantitative easing facilitated the growth in identify fiscal space for productive SDG investments. A balance borrowing. Developing countries, including LDCs, increased sheet approach that clarifies how borrowed resources are access to commercial financing. Lending by non-Paris Club used, taking into account public assets created, can lead to official creditors has increased, opening new opportunities better understanding of the impact of investment on fiscal for borrowers to finance development. However, the shifting revenue and gross domestic product (GDP). SDG investments creditor landscape has also changed the structure of the debt that boost productive capacity in countries can help generate of borrowing countries, increasing their exposure to inter- revenue to meet debt service requirements when investment est rate, exchange rate and rollover risks. With commercial projects are carefully selected, sustainably financed and debt accounting for a growing share of sovereign borrowing, effectively executed. The Financing for Sustainable Develop- debt-service burdens are increasing. Steep increases in private ment Report 2019 also looked at the role that well-managed, sector debt, particularly non-financial corporate debt in emerg- fiscally sustainable and transparent national and re- ing markets, have further increased countries’ vulnerabilities to gional development banks can play, building on the call for external shocks and capital flow reversals. strengthening them in the Addis Ababa Action Agenda. Rising debt-service costs diminish fiscal space for countercy- Effective debt management is essential to mitigating risks. clical measures and for investments in long-term structural Strengthening debt management through technical assis- transformation and the Sustainable Development Goals (SDGs). tance and capacity-building will help countries manage debt This is a major concern in light of large, unmet SDG investment more effectively. Despite some progress, debt management needs. This calls for a range of national and global actions in capacity and transparency need to be continually enhanced in three areas: (i) creating additional fiscal space; (ii) prevent- light of the growing complexity of the creditor landscape and ing debt crises; and (iii) advancing the policy agenda on debt debt instruments. While the primary responsibility for debt restructuring. transparency lies with debtors, creditors share the responsi- Increased domestic revenue mobilization and more effective bility for making the terms and conditions of lending public, spending, along with official development assistance (ODA), straightforward, and easy to track. To help borrowers avoid can help countries scale up public investment to meet the SDGs debt traps, official creditors should pay appropriate attention 127 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

to not adversely affect debt sustainability in borrower countries, includ- management, transparency, and sustainable finance principles), innovative ing by providing financing on more concessional terms and ensuring that financing instruments, and debt crisis resolution. lending practices are fully in line with sustainable, responsible financing practices. Debt vulnerabilities have increased in many cases due to climate and 2. Recent trends in debt burdens environmental shocks. Innovative mechanisms, such as state-contingent debt instruments, would allow debtor countries to postpone payments 2.1 Global debt trends in the event of specified shocks. Despite a measure of analytical work Global debt continues to rise. Total global debt stocks grew over 5 per cent on such state-contingent loans, there has been limited uptake on the in 2018 to reach $228 trillion (or 267 per cent of global GDP), compared to part of private or official creditors. Official creditors can take the lead in $152 trillion (239 per cent of global GDP) at the onset of the global financial using such instruments and promoting their uptake, which is essentially crisis in 2008 (figure III.E.1A). The growth in global indebtedness has been a contractual approach to creating “breathing space” for a borrowing driven by an explosion of private sector debt since the 1980s. In developed country in periods of stress. countries, the growth rate for debt decelerated after the initial increase in Experience in recent years indicates that the new landscape has compli- public debt in the wake of the global financial crisis. In developing coun- cated and lengthened the process of debt restructuring. This raises the tries, however, both public and private debt increased, with private debt social cost of debt crises, including on the poorest citizens. Further work accelerating particularly sharply following the crisis (figure III.E.1B). in the international community is thus warranted in order to revisit Global factors have been a significant driver of debt flows to developing existing mechanisms and arrive at a fair, effective and timely interna- countries. As noted in chapter 1, quantitative easing in developed econo- tional process for debt resolution. Progress in all these areas is needed if mies in the aftermath of the 2008 crisis (with interest rates close to zero countries are to achieve the SDGs by 2030. The United Nations can provide or negative) fuelled investors’ search for yield, which allowed a growing a forum for informal and inclusive dialogue among all stakeholders that number of developing countries to borrow from commercial sources. Quan- considers policy options for financing SDG investments while maintain- titative easing also reached corporate balance sheets in middle-income ing sustainable debt. countries, as emerging market corporate bonds provided high-yielding This chapter first examines debt trends at the global level and in develop- investment opportunities. ing countries, exploring developments of debt risk assessments, and the At the same time, global economic growth remains sluggish. Softer growth underlying changes to public and private debt levels and the composition rates in low-income and least developed countries have coincided with of debt. The remainder of the chapter explores policy options to mobilize rising interest costs associated with the growing share of commercial debt finance for SDG investment while maintaining sustainable debt, through over the last decade. This has contributed to worsening underlying debt responsible borrowing and lending (debt sustainability assessments, debt dynamics in these countries.

Figure III.E.1 A. Total debt, global, 1960–2018 (Trillions of United States dollars)

250

200

150

100

0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2018

Private debt Public debt

Source: UNCTAD Secretariat calculations, based on the IMF Global Debt Database. 128 DEBT AND DEBT SUSTAINABILITY

B. Total debt, developed and developing countries, 1960–2018 (Percentage of GDP)

Developed countries Developing countries

350 200

300

150 250

200 100 150

100 50

0 0 1960 1970 1980 1990 2000 2010 2018 1960 1970 1980 1990 2000 2010 2018

Private debt Public debt

Source: UNCTAD Secretariat calculations, based on the IMF Global Debt Database.

2.2 Development of debt risk assessments Figure III.E.2 IMF-World Bank ratings resulting from Overall, and prior to the COVID-19 outbreak, International Monetary Fund low-income-country debt sustainability assessments (IMF) projections pointed to stabilizing debt-to-GDP ratios for low-income (Percentage of PRGT-eligible low-income developing countries) developing countries going forward, after several years of upward revi- 100 5 5 5 5 sions. Nonetheless, debt sustainability assessment stress tests suggested 11 13 7 13 14 16 17 19 19 that many countries remain exposed to a downgrade in the event of 16 16 17 global shocks. 21 21 80 21 24 27 29 COVID-19, along with the sudden and dramatic drop in oil prices, has 28 27 26 22 significantly increased the likelihood that such shocks—particularly weaker-than-expected global growth and a decline in commodity 60 43 44 36 48 prices—materialize. About 44 per cent of low-income developing coun- 33 34 48 tries eligible for the IMF Poverty Reduction and Growth Trust (PRGT) were 33 41 33 assessed at high risk of external debt distress or already in debt distress 40 31 30 38 before COVID-19 (figure III.E.2); Nineteen of them are LDCs. Ten countries, including six LDCs, were assessed to be in debt distress as of end-2019 20 36 36 (Eritrea, the Gambia, Grenada, Mozambique, the Republic of the Congo, 31 32 35 25 25 26 29 Sao Tome and Principe, Somalia, South Sudan, Sudan and Zimbabwe). 25 20 20 23 0 2.3 Public debt in developing countries 2007 20092008 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Low Moderate High In debt distress Median public debt in developing countries continued to grow in 2019, albeit at a slower pace. After growing as a share of GDP for most of the Source: IMF-World Bank LIC DSF database. past decade (from 35 per cent in 2012 to 49 per cent in 2019) the ratio of public debt to GDP is estimated to have stabilized across country groups (figure III.E.3). In LDCs and small island developing States, median 2.4 Changes in the composition of debt public debt was 47 and 58 per cent of GDP, respectively. Nonetheless, Despite declining slightly in 2018, borrowing on commercial terms out- the debt-service burden (debt service relative to government revenue) paced other sources of external credit in the last two years in developing continued to rise, primarily due to changes in the composition of countries. Multilateral debt grew by one percentage point of GDP between developing-country debt. 2016 and 2018, arresting the decline observed between 2010-2016. Official

129 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Figure III.E.3 Public debt, 2000–2019 (Share of GDP) Developing countries Middle-income countries

100 100

80 80

60 60

40 40

20 20

0 0 2018201620142012201020082006200420022000 2018201620142012201020082006200420022000 Least developed countries Small islands developing States

160 120

140 100 120 80 100

80 60

60 40 40 20 20

0 0 2018201620142012201020082006200420022000 2018201620142012201020082006200420022000

Median Third quartile First quartile

Source: UN DESA calculations, based on IMF WEO.

bilateral creditors’ lending has been broadly flat in recent years, with China Funding from international and domestic capital markets allowed accounting for a larger share versus a decade ago (figure III.E.4). countries to finance new investments, but not without consequence. Such Among commercial sources of credit, bond borrowing on interna- funding embodies higher cost and greater risk than traditional official tional capital markets continued to grow over the past two years. financing, and the relative decline in ODA has raised the average interest Foreign-currency denominated bonds have been the fastest grow- rates on external debt. Total public debt servicing is expected to amount to ing source of financing for frontier economies (low-income and least 13 per cent of fiscal revenues in low-income developing countries in 2019, developed countries with international bond issuance as well as other up from about 12 per cent in 2013. Before the crisis, the debt-servicing non-investment-grade, infrequent sovereign bond issuers1), mainly burden of the frontier economies was particularly high, absorbing over 25 in sub-Saharan Africa. Local currency debt has also surged, with per cent of their public revenues in 2019, compared to under 15 per cent non-resident holdings continuing to grow in a handful of countries. In before 2015. In addition, foreign investment in local capital markets, while Ghana and Senegal, for example, foreign holdings have reached one third bringing additional sources of capital to domestic firms, can also create of domestic debt at times, while in other countries, their share has been vulnerabilities in the form of volatile capital flows when investors have increasing, albeit from a lower base. short-term horizons and when global risk perceptions change (see chapter III.F for policy options to address capital flow volatility). 130 DEBT AND DEBT SUSTAINABILITY

At the same time, average maturities on new external commitments particularly affects frontier economies with access to international debt continued to fall, further increasing rollover risk. Between 2017 and 2018, markets. These countries’ Eurobond refinancing needs will rise over the the average maturity on external debt decreased from 21.6 to 20.6 years, next 5 years to an annual average of almost $5 billion, up from less than extending a declining trend that began in 2010. The increased rollover risk $2 billion in 2017-2018. Of particular concern are countries where debt redemptions represent a high proportion of foreign exchange reserves (figure III.E.5). Figure III.E.4 Disbursed debt by creditor type, 2007–2018 (Percentage of GDP) 2.5 Private debt trends in developing countries The growth of private sector debt remains a major driver of total debt 3.5 growth in developing countries. At the end of 2018, it accounted for 139 per cent of their GDP (see figure III.E.1B above). Lending to non-financial 3.0 corporations in emerging markets2 and China in particular accounts for the 0.8 bulk of this increase (figure III.E.6). But even in low-income countries with 1.0 2.5 shallow financial systems, private sector debt now stands at around 18 per 0.7 0.1 0.4 cent of GDP, up from about 12 per cent just before the start of the global 0.4 0.5 0.3 2.0 0.5 0.3 0.7 financial crisis. 0.3 0.6 0.7 0.1 0.2 0.7 0.7 0.6 Growing private sector debt raises debt sustainability concerns. As noted 1.5 0.2 0.2 0.5 0.7 0.1 0.5 0.5 above, low global interest rates and a search for yield by international 0.2 0.2 0.3 0.1 0.2 0.5 0.3 0.3 0.2 0.1 0.3 0.3 0.3 0.1 0.1 investors facilitated the growth in private credit. Outside of China, where 1.0 0.1 0.1 0.1 0.1 0.1 0.1 0.1 corporate bonds are primarily domestically owned, external creditors hold 1.4 a significant share of large developing countries’ corporate debt (about 0.5 0.9 1.1 1.0 1.0 1.0 0.8 0.8 0.8 0.9 0.9 0.8 one third of non-financial sector corporate debt, or about $1.8 trillion, in 26 emerging-market countries excluding China).3 The build-up in 0.0 2007 20092008 2010 2011 2012 2013 2014 2015 2016 2017 2018 external foreign currency borrowing makes countries vulnerable to capital Multilateral Plurilateral Paris Club flow reversals and currency crises, and endangers financial stability and ultimately public debt sustainability (see chapter III.F.) Non-Paris Club Commercial Of particular concern is that this proliferation of private debt does not Source: IMF and World Bank (2020). The Evolution of Public Debt Vulnerabilities in appear to have boosted productive investment: the growth of corporate Lower-Income Economies. debt has outpaced the speed of capital formation in many developing

Figure III.E.5 Foreign currency debt redemptions of frontier economies (Dollars and percentage) Foreign currency debt redemptions Foreign currency debt redemptions, 2019-2028 (Billions of United States Dollars) (Percentage) 12 25 300

As a % of GDP (LHS) 10 As a % of Reserves (RHS) 250 20

8 200 15

6 150

10 4 100

5 2 50

0 0 0 2028202720262025202420232022202120202019

Kenya Benin Nigeria Bolivia Ghana Sub-Saharan Africa Latin America Asia Ethiopia SenegalZambia Vietnam Pakistan Sri Lanka TajikistanHonduras Mongolia Uzbekistan Cameroon Cote d'Ivoire Europe & Central Asia Mozambique

Papua New Guinea Source: IMF and World Bank (2020) “The Evolution of Public Debt Vulnerabilities in Lower-Income Economies” based on Bloomberg, IMF WEO, and IMF sta estimates. 131 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Figure III.E.6 Total credit to non- nancial corporations, advanced and emerging economies, 2000–2018 (Percentage of GDP) 120

100

40 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Advanced economies Emerging markets

Source: UNCTAD secretariat calculations, based on BIS Credit Statistics. Credit to non- nancial corporations is from all sectors at market value.

countries (see Financing for Sustainable Development Report 2019). The creditworthiness of non-financial corporates has been deteriorating.4 3. Sustainable and responsible In some countries, public debt sustainability could also be at risk from borrowing and lending for the SDGs rising debt of state-owned enterprises (SOEs). Their debt accounts for a significant portion of total emerging-market debt (figure III.E.7). Similar to private companies, many SOEs have taken advantage of the easy global 3.1 Debt sustainability and SDG investments financial conditions over the past decade to significantly increase their Debt is a key source of financing for sustainable development and the SDGs. hard currency debt. Rising SOE debt could impact on the Government’s Indeed, many SDG investments can generate the resources to repay debt. fiscal position, particularly in countries with high debt. Yet, the size of SDG financing gaps puts into question developing countries’ ability to mobilize sufficient public debt financing to achieve the SDGs Figure III.E.7 while maintaining sustainable debt levels—particularly since debt levels Debt outstanding in emerging markets: are already elevated in many low-income and least developed countries. hard currency bonds by type, 2013 and 2019 For example, the IMF estimates that investments in SDGs in five areas that (As share of external debt) typically require public spending (education, health, roads, electricity, 2019 water and sanitation) would require additional annual spending of about 15 percentage points of GDP in the poorest countries.5 Under realistic assumptions about revenue mobilization, ODA, and FDI, the additional spending needed could only be achieved by borrowing on a large-scale on 2013 commercial terms that would lead to a sharp increase in interest burdens and debt vulnerabilities.6 The United Nations Conference on Trade and De- velopment (UNCTAD) estimates that, if financed from additional borrowing, meeting SDGs 1-4 by 2030 would lead to dramatic increases in developing countries’ public debt (see box III.E.1), increasing vulnerabilities. The challenge for countries is how to create fiscal space for additional public investment in the SDGs, particularly for heavily indebted countries. The solution goes beyond this chapter to include policies across the Addis Agenda, including strengthened fiscal management (increased domestic public Sovereign hard currency bonds SOE hard currency bonds resource mobilization and efficient spending) (chapter III.A); access to Corporate hard currency bonds Other concessional financing (chapter III.C); domestic and international macroeconomic and capital account management (chapter III.F); and other measures Source: IMF (October 2019), Global Financial Stability Report. discussed throughout this report. There is also a need for efforts, discussed 132 DEBT AND DEBT SUSTAINABILITY

Box III.E.1 Developing-country debt sustainability and the Sustainable Development Goals The debt sustainability analysis presented here operationalizes the debt sustainability definition proposed by former Secretary-General Kofi Annan in 2005. Updating this definition to meet the 2030 Agenda for Sustainable Development, debt sustainability is defined as the set of policies that allow a country to achieve the Sustainable Development Goals (SDGs) and to reach 2030 without an increase in debt ratios. The analysis focuses on the impact that meeting only the first 4 of the 17 SDGs (poverty elimination, nutrition, good health and quality education) would have on developing-country debt sustainability. Most investments in these SDGs do not offer competitive financial returns and are expected to be met by the public sector. The analysis is based on a sample of 30 developing countries across developing regions and consists of three components. The first component (figure III.E.1.1A) projects the impact of the investment required to meet SDGs 1-4 on the evolution of developing-country public (gross central government) debt until 2030. It compares a business-as-usual or baseline scenario, which assumes that countries maintain current expenditure patterns and that short-term debt sustainability requirements remain in place, with an “SDG public debt scenario”. In the baseline scenario, average public debt is expected to increase from 47 per cent of gross domestic product (GDP) in 2018 to 51 per cent by 2030. The second scenario assumes that Governments depart from business-as-usual practices to meet SDGs 1-4 on time and without external assistance other than current official development assistance grants. Meeting the investment requirements of these SDGs would have a major impact on public debt, with the ratio of public debt to GDP increasing to 184.7 per cent of GDP by 2030, on average. The sharpest increase would, unsurprisingly, be experienced in low-income countries. Unless alternative sources of funding become available, the most vulnerable countries and those in most need of urgent investments to meet the SDGs would thus be least likely to afford SDG investments without triggering a debt crisis. The second component (figure III.E.1.1B) estimates the SDG debt sustainability gap—that is, the difference between the primary fiscal balance consistent with achieving SDGs 1-4 by 2030 and the balance required to maintain stable public debt ratios. Developing countries would, on average, require 11.9 per cent of their GDP in additional annual resources. The third component (figure III.E.1.1C) considers domestic and external financing options. Even under potentially optimistic assumptions about fast improvements to domestic resource mobilization, meeting investment requirements for the first four SDGs would require significant external assistance, in particular for least developed countries and other low-income countries.

Figure III.E.1.1 Developing-country debt sustainability and the Sustainable Development Goals (Percentage) A. Public debt scenarios with and B. Achieving the SDGs at current public-debt C. Closing the SDG debt-sustainability without SDG-related investment burdens: The SDG debt-sustainablity gap gap: Domestic and multilateral (Percentage of GDP) (Gap as a percentage of GDP) nancing options 300 25 100

250 20 80

200 Average 184.7 15 60 150 Average 11.9 10 40 100

5 20 50

0 0 0 AsiaAfrica LMICsLICsLatin UMICs AsiaAfrica LMICsLICsLatin UMICs AsiaAfrica LMICsLICsLatin UMICs America America America Public debt SDG scenario (2030) SDG gap SDG DRM SDG ODA Public debt baseline scenario (2030) SDG Debt relief

Source: UNCTAD secretariat calculations, based on IMF WEO, WDI, QEDS, FAO (2015), Stenberg and others (2017), UNESCO (2016) and national sources. Note: LICs= low-income countries; LMICs= lower-middle-income countries; UMICs= upper-middle-income countries. Classifications are World Bank classifications that, for the included countries, are identical with UNCTAD classifications but provide the additional breakdown into LMICs and UMICs. Figures represent unweighted averages per country group. The sample is composed by region and income category: Africa: Benin (LIC), Ethiopia (LIC), Malawi (LIC), Mali (LIC), Mozambique (LIC), Uganda (LIC), United Republic of Tanzania (LIC); Algeria (LMIC), Cameroon (LMIC) and Kenya (LMIC). Asia: Afghanistan (LIC), Nepal (LIC); Bangladesh (LMIC), Cambodia (LMIC), India (LMIC), Indonesia (LMIC), Myanmar (LMIC), Pakistan (LMIC), Viet Nam (LMIC); Thailand (UMIC). Latin America and the Caribbean: Haiti (LIC); Plurinational State of Bolivia (LMIC) and Nicaragua (LMIC); Brazil (UMIC), Colombia (UMIC), Dominican Republic (UMIC), Ecuador (UMIC), Jamaica (UMIC), Mexico (UMIC) and Peru (UMIC). Source: UNCTAD.

133 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

in the remainder of this chapter, to create space for productive investments It is expected that a final set of proposals will be considered by the IMF Ex- in the SDGs, including through the use of innovative debt instruments; ecutive Board during 2020 and introduced in country analyses during 2021. better identify fiscal space and debt vulnerabilities through strengthened analytical tools; and promote sustainable lending and borrowing practices 3.4 Public debt management through strengthened debt management and transparency, and by further advancing the policy agenda on responsible borrowing and lending. Strengthened debt management is important because it can both free up resources for investment and reduce the risk of debt crises. Developing countries have, in most cases, been making progress with strengthening 3.2 Identifying opportunities: a balance sheet approach debt management. The results from 39 countries that have more than one Productive investments, while increasing debt ratios in the short run, can debt management performance assessment (DeMPA)9 evaluation over the generate future revenue and higher growth, leading to lower debt ratios period 2008-2018 reveal improvements for 11 out of 14 dimensions (figure over time and creating a positive feedback loop. It is important for heavily III.E.8). However, gaps in debt management remain. For example, frontier indebted countries to analyse the impact of investment and overall risks economies failed to make progress in debt reporting and auditing and in presented by assets and liabilities in order to better understand where they the formulation of debt management strategies. Of particular concern is could have fiscal space. A balance sheet analysis can help in this regard. the fact that debt management capacity may not be keeping up with the For instance, El Rayess and others demonstrate that better managed infra- increasing complexity of debt instruments where it is most needed (i.e., structure investment could improve the long-term balance sheet impact frontier markets). A related concern is that debt management might not by almost half in some countries.7 Another example is the Gambia, where always be sufficiently long-term focused. For example, during the period balance sheet analysis brought out the interlinkages of fiscal risks in the of extremely low interest rate levels, many countries have been taking on public sector, allowing the authorities and donors to assess where to best loans using floating rate debt instruments, which tend to benefit lenders, intervene to reduce these risks.8 And managing public assets better opens even when longer-term debt may be available at a reasonable cost. up the potential to raise considerable additional revenue, which in turn can Other areas of concern include suboptimal borrowing frameworks; be invested in achieving the SDGs. insufficient audits; lack of operational risk management; poor cash At the same time, predicting the impact of borrowing for investment on flow forecasting and management; insufficient staff capacity in debt growth rates (e.g., in the context of debt sustainability assessments (DSAs)) is management offices; partial debt coverage; and limited reports. Indeed, extremely challenging, due to uncertainties around investment efficiencies and developments in 2019 underlined the continued need to enhance down- growth feedback. To address the potential feedback, the IMF and World Bank stream debt management capacity (debt data recording and validation, included a “realism tool” in their July 2018 update to the low-income countries’ debt operations, and debt reporting and statistics) as part of international debt sustainability framework (LIC-DSF). The realism tool uses a simple growth efforts to address ongoing problems with debt data transparency. accounting framework and decomposes projected growth rates into contributions from changes in the government capital stock (due to public investment) 3.5 Debt data, reporting and transparency and all other sources. It shows projections for public and private investment, Timely and comprehensive data on the level and composition of debt are a and historical and projected contributions of public investment to growth. prerequisite not only for the effective management of public liabilities, but also for identifying risks of debt crises and limiting their impact. Indicators 3.3 Debt sustainability assessments: improving analytical of debt transparency have improved over time. For the 39 countries with tools more than one DeMPA during 2008-2018, all but one data transparency indicator improved between the last two DeMPAs. One third of low-income Correctly picking up investment growth linkages—as encouraged by the re- developing countries also regularly publish statistical debt bulletins, alism tool in the new LIC-DSF) – is one element of a robust debt sustainability including two thirds of frontier markets. analysis. The LIC DSF also newly incorporates other key elements, including additional stress tests tailored to country-specific economic vulnerabilities, Nonetheless, significant problems remain in many countries with both increased requirements for debt transparency, and broader debt coverage. the quality of public debt data and the level of reporting. Faced with To date, eleven countries have expanded the coverage of public debt beyond increasingly complex portfolios and the growing importance of domestic the standard general government to include key SOEs. Consistent with the financing, many countries have yet to reach the minimum standards in message from balance sheet analysis, it is important to correctly capture SOE some key areas. High staff turnover continues to be a common and recur- debt repayment capacity when adding them to a DSF analysis. rent problem. Limited coverage of total public debt is another common problem, with specific difficulties relating to subnational debt and The IMF is also currently reviewing the framework for assessing debt contingent liabilities. For example, three quarters of countries that have sustainability in countries with significant access to international debt used the new LIC DSF have debt coverage of, at most, public and publicly markets (market-access country debt sustainability analysis, or MAC DSA). guaranteed central government debt (including central bank debt) only. Based on back-testing analysis and consultations with IMF stakeholders, the review seeks to propose more comprehensive and consistent coverage In response, international organizations have continued to step up their ca- of debt-related risks facing countries; incorporate relevant country-specific pacity development efforts. The Multi-Pronged Approach (MPA) of the IMF factors in the analytical tools to improve the framework’s discriminatory and the World Bank provides a framework to help address debt vulnerabili- capacity; better capture uncertainty around baseline assumptions; and ties and close debt management gaps where they exist. UNCTAD, through provide more structure for the application of judgment in the assessment. its Debt Management and Financial Analysis System (DMFAS) Programme, 134 DEBT AND DEBT SUSTAINABILITY

Figure III.E.8 Change in DeMPA results (Percentage of the number of countries meeting minimum requirement)

Legal Framework 30 Debt Records Managerial Structure 20 Segregation of Duties, Sta Capacity and BCP 10 Debt Management Strategy 0 –10 Debt Administration Evaluation and Reporting –20 and Data Security

Cash Flow Forecasting and Audit Cash Balance Management

Loan Guarantees, Coordination with Fiscal Policy on lending Derivatives

External Borrowing Coordination with Monetary Policy Domestic Borrowing LIEs LIDC Frontier market Developing market Diversied exporters Commodity exporters

Source: World Bank’s DeMPA results as of end-December 2018. The sample includes 39 DMF-eligible countries. launched the debt data quality assessment (Debt-DQA) framework to assess and monitor the quality of the data recorded in countries’ debt da- new and more complex debt instruments and practices; the increased tabases in November 2019, jointly with the Commonwealth Secretariat. In prevalence of domestic debt and private non-guaranteed external response to increasing demand, DMFAS expanded its support in 2019, sup- debt; and the increasing importance of monitoring contingent li- porting 85 institutions in 58 countries, and organizing 79 capacity-building abilities, public private partnerships (PPPs), extrabudgetary debt and events. DMFAS also launched a new strategy to respond to a more complex subnational debt. debt landscape (box III.E.2). To ensure debt data transparency in this new context, coverage will be expanded to include all central, state and local government debt, contingent liabilities, extrabudgetary debt, state-owned-enterprise Box III.E.2 debt and private non-guaranteed external debt. As a growing Debt Management and Financial Analysis System: a number of governments are moving from pure cash accounting new four-year strategy towards accrual accounting, the strategy will support the application of accrual-based international standards for government fiscal To address the increasing complexity of the debt landscape, the and financial reporting, including the Government Finance Statistics United Nations Conference on Trade and Development (UNCTAD) Debt Manual (GFSM) and the International Public Sector Accounting Management and Financial Analysis System (DMFAS) Programme has Standards (IPSAS). Extensive capacity-development will be provided launched a new four-year strategy. Focusing on the delivery of techni- through a framework of traditional training and online courses. A cal assistance in the programme’s areas of comparative advantage new version of the software, DMFAS 7, will respond directly to the (i.e., the “downstream” areas of debt management), this strategy requirement to improve debt data transparency by expanding debt complements the work of the World Bank and the International data coverage, enhancing reporting functions and implementing Monetary Fund (IMF), whose focus is primarily on data sustain- necessary major technical updates. Effectiveness of delivery will ability analysis and medium-term debt strategies (“upstream” debt improve through establishing regional offices and cooperation with management). other providers of technical assistance in debt management, includ- Additional challenges and risks for transparency arise from new credi- ing the World Bank, the IMF and regional organizations. tors working outside current structures (the Paris Club, for instance); Source: UNCTAD.

135 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

3.6 Responsible borrowing and lending also legislate that sovereign debt transactions are not collectible if certain transparency conditions have not been met. Soft-law mechanisms could As rising debt risks threaten achievement of the SDGs in the context of a thus form a foundation for eventual legal initiatives. more complex debt landscape, renewed attention is warranted to the commitment, made in the Addis Agenda, to work towards a global consensus on guidelines for debtor and creditor responsibilities, building on existing initiatives. Multiple complementary sustainable financing initiatives are 4. Innovative debt instruments currently underway to promote responsible borrowing and lending. Different types of innovative debt instruments have been proposed, and some implemented on a small-scale or pilot basis. Their main aim is to The IMF’s revised Debt Limits Policy, and the World Bank’s new Sustainable either (i) create room for additional investments in the SDGs or (ii) better Development Financing Policy are both expected to take effect during the manage shocks and risks. For example, debt swaps and related mecha- second half of 2020. Both policies aim for sharper alignment with the new borrowing landscape, including allowing opportunities to borrow (subject nisms generally do not reduce a country’s debt burden; rather they swap a to safeguards); creating better targeting conditions at vulnerabilities; and country’s debt-servicing payments for investments in sustainable develop- supporting strengthened debt transparency and debt management. The ment. State-contingent debt instruments can also create additional fiscal International Institute of Finance has articulated Voluntary Principles space, but their primary objective is to help countries better respond to covering debt data disclosures by private creditors. Given the potential for shocks by preserving fiscal space in times of crises. agency problems in borrowers—where borrowing may not always be duly authorized—disclosure by lenders is an important avenue to achieving 4.1 Debt swaps and related innovative mechanisms to accountability. The initiative is expected to come to fruition during 2020, create fiscal space for SDG investments upon identification of a host for the data, which would need to be acces- Debt swaps allow countries to use funds otherwise tied up in debt servic- sible by the public. ing for a social or environmental initiative. There are several examples of The Group of Twenty (G20) articulated their Operational Guidelines for debt swaps that sprang up during the 1980s debt crisis.12 In debt-for- Sustainable Financing in 2017. Their aim is to “enhance access to sound nature swaps, an international non-governmental organization (NGO) financing for development while ensuring that sovereign debt remains would purchase external debt and offer the debt for cancellation in on a sustainable path by fostering information sharing and cooperation exchange for a conservation commitment. Alternatively, debt would be among borrowers, creditors and international financial institutions, as exchanged for local currency that local conservation groups or govern- well as learning through capacity building”.10 The G20 has made use of ment agencies would use to fund projects in the debtor country. In the a diagnostic tool developed with the assistance of IMF and World Bank Seychelles, a $15 million loan from the Nature Conservancy and $5 million staff in 2019 to help creditors diagnose their level of compliance with the worth of grants from various foundations was used to purchase $20 million 17 practices underlying the G20 operational guidelines.11 To date, 15 G20 worth of Seychelles debt held by European nations, which freed up $6 members and 5 non-members have completed the self-diagnostic, with 12 million for the Seychelles to use on marine conservation. The debt was also following up on their results with IMF and World Bank staff. restructured to extend average maturity on the notes from 8 to 13 years, The G20 approach is operationally oriented, given the close links to the with about a quarter of the debt to be paid in local currency. This spread operations of IMF and World Bank and the supporting self-diagnostic the debt burden over a longer time and lowered the cost of repayment for tool. The UNCTAD principles on promoting responsible sovereign lending the Nature Conservancy. and borrowing provide a conceptual framework to guide best practices in Debt swaps have also been used for social objectives, such as the Debt- sovereign lending and borrowing. They aim to establish a balance between 2Health initiative, facilitated by the Global Fund to Fight AIDS, Tuberculosis responsibilities of lenders and borrowers; focus on safeguarding the public and Malaria, where creditors waive repayment of a portion of their loan to interest in sovereign debt financing and contracting; and call for a holistic a country that, in return, invests an agreed amount in health. In the latest approach to the evaluation of public investment projects and adequate swap under this initiative, in 2017, Spain cancelled €36 million in outstand- management and monitoring to minimize incidences of over-borrowing ing debts owed by Cameroon, the Democratic Republic of the Congo and and avoid restructuring. Ethiopia, in exchange for €15.5 million in investments in domestic health While these quasi-legal (“soft-law”) initiatives are voluntary and programmes supported by the Global Fund. Debts swapped under this non-binding, they nonetheless can make an important contribution to initiative amounted to €200 million until 2017.13 More recently, ECLAC promoting responsible borrowing and lending. By enhancing transpar- proposed a debt for climate swap where the Green Climate Fund would ency and promoting cooperation between debtors and creditors, they can buy some of the external debt of participating countries and, instead of help address (albeit not remove) collective action problems and mitigate making debt-service payments, countries would make payments into a information asymmetries that arise in the area of sovereign debt. Soft-law resilience fund, which would finance green investments (see box III.E.3). initiatives will be most effective if information provided is comprehensive Similar to the ECLAC initiative, an SDG debt swap programme could support (covering all types of debt and debt instruments) and accessible, and if SDG-related investments in developing countries. The international compliance is further incentivized through mechanisms to promote ac- community and/or NGOs could make an initial contribution to the countability or other complementary measures. programme that would be used to purchase external public debt (from Adjudicative bodies—national courts, for example—could use such either private or public creditors). The beneficiary countries would commit principles to guide their actions and decision-making. Jurisdictions could to pay into an SDG investment fund, or invest directly in projects of 136 DEBT AND DEBT SUSTAINABILITY programmes, in the amount that they would have paid to their former million were disbursed by end-2018. The French loan allows the borrower creditors as debt service.14 A global SDG-related concessional lending to postpone the last five years of an otherwise ten-year grace period and programme would be another option. Such a lending facility could include use it at any time during the remaining maturity of the loan to meet a pay- a refinancing facility to allow participating countries to borrow on ment exigency. This flexibility, however, comes at a cost and may explain concessional terms in order to progressively repurchase the outstanding why the model has not been emulated by others. stock of public external debt issued on commercial terms. The principal Other types of state-contingent bonds have been conceived—in particular, benefit would be a reduced interest rate and an extension on the bonds with a link to the borrowing country’s GDP (i.e. GDP-linked bonds), maturities of the debt swapped. While not a debt workout mechanism per including the drafting of a term sheet.16 In such bonds, interest obliga- 15 se, it could help countries avoid a debt crisis. One risk with debt tions grow larger when countries experience strong growth and shrink buy-backs of market debt is that bond prices will rise once the programme when economic conditions deteriorate. While bonds have been issued that is public. A strict maximum buy-back price formula in the programme pay additional interest if an economy’s growth is greater than expected, terms of reference can help overcome this issue. no bonds have yet been issued when the bondholder risks receiving less than baseline interest in the event of a negative turn of economic events. Box III.E.3 Official creditors could consider using such instruments, which essentially create “breathing space” for a borrowing country in economic downturns The Debt for Climate Adaptation Swap initiative as part of the debt contract, and can thus help prevent debt distress. The Economic Commission for Latin America and the Caribbean Islamic sukuk instruments also share risk between borrower and lender. (ECLAC) has proposed a swap of some of the region’s external debt In the sukuk bond issued by the British Government in 2014, for example, for debtor-country commitments to make annual payments into the income payments to the investors are paid from profits based on the rental new Caribbean Resilience Fund. In the proposal, the Green Climate payments from government-owned properties. Other Governments that Fund would buy up some of the external private debt of participating have issued sukuk bonds structured in different ways include Indonesia, countries at a discount. For their part, the Caribbean countries would Luxembourg, Malaysia, South Africa, Turkey, and Hong Kong SAR. Sukuk commit to pay into the new Caribbean Resilience Fund the amount have been backed by revenues from infrastructure projects or exports.17 that they would have paid as debt servicing to its former creditors There are additional potential sukuk and other Islamic financial instru- (see Financing for Sustainable Development 2019). ments that could inspire the development of financial instruments with Three “Phase One” countries (Antigua and Barbuda, Saint Lucia, risk-sharing aspects attractive to lenders and borrowers. and Saint Vincent and the Grenadines) are moving ahead. Antigua and Barbuda has proposed the use of its Paris Club debt to pilot the scheme, which collectively totals of over $130 million in debt. At the same time, ECLAC is in discussions with the Caribbean Development 5. When sovereign debt relief is Bank and the Caribbean Development Fund about housing and warranted management of the Caribbean Resilience Fund. The international community has struggled to devise better processes and Source: ECLAC. standards for resolving sovereign insolvencies. In the absence of a more systemic and multilateral solution, the current focus of policymaking to resolve sovereign insolvencies has been on contractual solutions, such as 4.2 State-contingent debt instruments the inclusion of enhanced collective action clauses (CACs) in bond contracts. State-contingent debt instruments contain a trigger mechanism that The new standard is a “single-limb” aggregated voting mechanism, which automatically defers debt-servicing payments that fall due during a crisis allows a qualified majority of bondholders across all bond series to bind of specified type. A number of bonds with state-contingent clauses in their an uncooperative minority in any of the bond series to the terms of a contracts have been issued, notably for countries in the Caribbean where proposed restructuring. According to the most recent IMF progress report the trigger is the advent of a hurricane of specified severity. To date, these on sovereign debt, published in March 2019, almost 90 per cent of all bonds have not been introduced except by Governments restructuring bonds issued under New York and English law since these clauses were first their debt (Barbados being the most recent example). introduced now include them. While the clauses will restrict the ability of At the request of the Eastern Caribbean Central Bank, the IMF and World disgruntled bondholders to seek redress in courts, research has demon- Bank jointly examined possible structures for such instruments, which strated that there is no observable impact of including the new voting were translated into draft “term sheets” by the International Capital mechanism on the prices of the bonds at the time of issuance. Inclusion of Markets Association, in collaboration with the law firm Clifford Chance. A these clauses may even lower borrowing costs, as they reduce the ability variant of these term sheets has also been endorsed for use on a voluntary of a minority of bondholders to disrupt a restructuring agreement. Euro basis by Paris Club creditors. So far, the only significant lending with area finance ministers also recently announced broad support for requir- state-contingent clauses by an official creditor was by Agence Française de ing single-limb CACs in all bonds issued by euro area sovereigns as of 1 Dèveloppement, which provided countercyclical loans for project financ- January 2022. ing to Mali, Mozambique, Senegal and the United Republic of Tanzania Despite this progress, the current framework has some limitations. While between 2008 and 2016 for a total amount of €299 million, of which €215 uptake of enhanced CACs is high in bonds governed by New York and

137 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

English laws (which represent 97 per cent of all international sovereign growing concerns about reaching timely and effective debt crisis workouts bonds), bonds issued in other jurisdictions, such as Asia, do not include without an agreed international debt-restructuring process. In the case of enhanced CACs. Moreover, given that there is no retrospective application, Chad, an inadequate first restructuring agreement raised the net present the outstanding stock of bonds without enhanced CACs remains large, value of the loan through the imposition of fees (i.e., no effective debt at over 60 per cent. The single-limb voting procedure has also not yet reduction). It required the country to restructure twice—in 2015 and been tested in a sovereign debt restructuring. The debt of SOEs in some 2017—in circumstances involving a commercial collateralized lender. For countries could represent a growing complication, as most foreign-law the Republic of the Congo, a restructuring that began in early 2018 remains bonds issued by SOEs do not have enhanced CACs, and indeed may not incomplete (a year-long negotiation with a non-Paris Club creditor recently include CACs at all (the same applies to subnational government bonds). reached conclusion, but the authorities continue to be in discussions with Also, borrowing from individual financial institutions has increased, which external commercial commodity traders to restructure collateralized may prove problematic, as a collection of individual loans from different debt). The Gambia’s restructuring took two years to reach agreement in banks would not have collective voting procedures (unlike syndications). principle, complicated by the large role of non-Paris Club creditors and They may also raise transparency concerns, as their terms are often not plurilateral institution lenders (and notwithstanding the helpful efforts disclosed publicly. of the largest creditor to move the process forward). Finally, Mozambique The increased use of loans collateralized with a country’s assets (such as only recently reached an agreement with its bondholders, three years after oil-related payment streams or stock in a state enterprise) or future tax first announcing the proposal, but other loans remain under negotiation/ revenue streams may also pose challenges. This may trigger negative litigation. For comparison, the average duration of restructuring with pledge clauses in other creditors loan contracts, requiring provision of commercial creditors (banks and bondholders) over 1998-2015 was about 18 equivalent collateral to them. Creditors holding access to collateral can also a year and half. use their bargaining position to extract more favourable terms, complicat- With the efficacy of existing processes to resolve debt crises in question, ing the restructuring process. Excluding project finance, collateralized urgent attention by the international community is warranted. Improve- borrowing represented, on average, 20 per cent of commercial borrowing ments to market-based approaches can be considered, including greater undertaken over the last five years (down from an average of 32 per cent use of innovations introduced by practitioners (e.g., trust structures), in the previous five years). But the averages conceal some large differences and potential extension of CACs to subnational debt. At the same time, across countries, with commodity producers in low-income developing proposals have been made to introduce basic practical steps for sovereign countries often heavily relying on this type of financing. debt restructurings. They include enforcement of a temporary standstill With regard to public creditors, the established mechanism for resolving on creditor litigation while debt-servicing payments are suspended by defaults, the Paris Club, represents a diminishing share of the stock of lend- the debtor government on its own initiative, requiring approval by an ing. Notwithstanding its efficient processes, the Club has been involved independent panel; and creditors providing “debtor-in-possession” financ- in few restructuring since 2015 (Grenada, and the pending treatment of ing, granting seniority status to debt after the imposition of the standstill, Somalia, at the HIPC decision point). Recent non-Paris Club restructur- which would give the debtor additional resources for financing imports 19 ings—which have been protracted and incomplete—appear to bear out and other vital current-account transactions.

Endnotes 1 They are Nigeria, Bolivia, Cote d’Ivoire, Papua New Guinea, Tajikistan, Uzbekistan, Zambia, Cameroon, Ethiopia, Ghana, Honduras, Kenya, Mongolia, Mozambique, Pakistan, Senegal, Sri Lanka, Tanzania, Vietnam 2 See Note at figure III.E.6 for countries included. 3 Institute of International Finance Global Debt Monitor Database. Based on 26 selected EMs. 4 Global Financial Stability Report, October 2019: Lower for Longer (Washington, D.C., IMF, 2019). 5 Vitor Gaspar and others (eds.), Fiscal policy and development: human, social, and physical investments for the SDGs (Washington, D.C., IMF, 2019). 6 Assuming flat official development assistance and foreign direct investment as a share of donor countries GDP per WEO forecast and tax revenues as a share of GDP at 3 percentage points higher than WEO forecast following IMF (2018b). 7 Majdeline El Rayess and others (eds.), Indonesia’s Public Wealth (Washington, D.C., IMF, 2019). 8 International Monetary Fund, African Department, “The Gambia: Selected Issues Paper”, The Gambia: Selected Issues, IMF country report 18/100 (Wash- ington, D.C., IMF, 2018). 9 The debt management performance assessment (DeMPA) is a methodology for assessing performance covering the full range of government debt management operations. It is focused on central government debt and loan guarantees. See http://www.worldbank.org/debt for a description of the DeMPA.

138 DEBT AND DEBT SUSTAINABILITY

10 IMF and World Bank, “G20 Operational Guidelines for Sustainable Financing—Diagnostic Tool,” Staff Note for the G20 IFAWG (Washington, D.C., IMF and World Bank, 2019). Available at https://www.imf.org/external/np/g20/pdf/2019/111519.pdf. 11 Ibid. 12 World Economic and Social Survey 2012: In Search of New Development Finance (United Nations publication, Sales No. E.12.II.C.1). 13 The Global Fund, “Spain, Three African Countries and the Global Fund Launch New Debt2Health Initiative”. Available at https://www.theglobalfund.org/ en/news/2017-11-29-spain-three-african-countries-and-the-global-fund-launch-new-debt2health-initiative/. 14 Trade and Development Report, September 2019: Financing a Global Green New Deal (United Nations publication, Sales No. E.19.II.D.15); and Munevar Daniel, “The sustainable development goals and developing-country debt sustainability: An alternative approach”, UNCTAD draft research paper. Available at https://unctad.org/en/programmes/debt-and-finance/pages/research.aspx. 15 Ibid. 16 UN DESA, Financing for Development Office, Technical Study Group Report, “Sovereign debt restructuring: further improvements in the market-based approach” (New York: Financing for Sustainable Development Office, 30 August 2017), pp. 18-21. Available at (http://www.un.org/esa/ffd/wp-content/ uploads/2017/09/EGM_sovereign-debt_Technical-study-group-report-30Aug2017.pdf). 17 A classic exposition on Islamic financial instruments for governments is: Ul Haque, Nadeem and Abbas Mirakhor, “The design of instruments for government finance in an Islamic economy”, IMF Working Paper No. WP/98/54 (Washington, D.C., IMF, 1998). Available at https://papers.ssrn.com/sol3/papers. cfm?abstract_id=882316. 18 Cruces Juan and Christoph Trebesch, “Sovereign Defaults: The Price of Haircuts”, American Economic Journal: Macroeconomics, vol. 5 Issue 3 (July 2013), pp.85-117. 19 Trade and Development Report, September 2019: Financing a Global Green New Deal (United Nations publication, Sales No. E.19.II.D.15).

139 Infographic Goes Here ADDRESSING SYSTEMIC ISSUES Chapter III.F

Addressing systemic issues 1. Key messages and recommendations

The international monetary system remains vulnerable to settlements, software and credit intermediation/risk-taking. A volatility and contagion, such as the recent financial volatility challenge for policymakers is to manage growing risks without as a result of COVID-19, as well as risks from increased lever- impeding innovation. There is growing experience with regu- age (see chapters I and III.E). Whether these have systemic lating fintech, and policymakers can build on the experiences of stability implications depends on the nature of international their peers to inform their decision-making. financial linkages and the timeliness and effectiveness of policy One area of rapid innovation is in digital payments and curren- responses. cies. Cashless economies are on the horizon. Digital payments, The financial reforms undertaken in response to the 2008 finan- such as mobile money, can reduce costs and promote financial cial crisis have been instrumental in bolstering the safety of the inclusion. Both the private sector and central banks are also banking system and addressing the risks, channels and mecha- proposing digital currencies. These could have efficiency nisms related to the crisis. Regulatory and supervisory bodies benefits, but also have the potential to fundamentally alter the should lead by example in promoting the timely, full and balance of risks and incentives in domestic financial systems, consistent implementation of remaining reforms. This will including financial integrity, financial stability, and sustainable support a level playing field and avoid regulatory arbitrage. development risks. Regulations on the operation of private Yet, as is normally the case, changes to the financial regulatory digital currencies should be carefully considered in each system after a crisis tend to focus on preventing a recurrence of jurisdiction, or regional currency zone, with policymakers past problems, while future shocks may have different causes considering financial stability, financial integrity, consumer and transmission channels. Yet, a retreat from multilateralism protection, privacy, and broader impacts on sustainable by some makes coordinated responses to global crises more development. Central banks considering the issuance of their challenging. own digital currencies should design systems that are well adapted to national contexts, and that contribute to sustain- Non-bank financial intermediaries are undertaking an increas- able development outcomes. ing share of financial intermediation, potentially generating new risks that should be understood and addressed. Countries Policymakers are also beginning to pay more attention to the should continue to step up efforts to track and regulate interaction of climate change and the financial system. There financial intermediation based on the function it performs is increasing recognition that climate risk is financial risk, and rather than the type of institution involved, including in re- these risks need to be incorporated in risk-based regulatory gards to fintech. The financial instruments described in chapter frameworks, building on the advances made in voluntary III.B, while helping to finance the 2030 Agenda for Sustainable disclosures. Policymakers should adopt global mandatory Development, can also create pockets of leverage that present financial disclosures on climate-related financial risk to sup- economic and social risks. The Inter-agency Task Force on Fi- port long-term stability of financial systems. Some countries nancing for Development (Task Force) will aim to explore these are also reforming their financial systems and regulation to relationships and ways to address the risks in future reports. ensure both financial stability and alignment with all aspects of the 2030 Agenda. Policymakers should also consider Financial technology is contributing to the growth of non-bank developing further policy frameworks and regulatory efforts financial intermediation and is blurring the lines between to promote sustainable financial systems. Regulations impact

141 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

incentives, and can encourage positive change in behaviours, such as regulation affects incentives, and there has been growing attention to the promoting financial inclusion and reducing investment in climate-change- impact of financial regulation on incentives for investment in sustainable inducing or other environmentally risky activities. development. The international community has brought together combinations of national and international policies to mitigate risk and cushion financial 2.1 Implementation of agreed reforms shocks when they do occur. These policies need constant adjustment if The Group of Twenty (G20) agreed to a number of financial regulatory they are to provide sufficient protection against the most devastating reforms through the Financial Stability Board (FSB) in the wake of the 2008 kinds of financial crises. New stresses on financial systems can arrive from world financial and economic crisis, with the final major policy reforms unexpected sources, much as the spread of COVID-19 in the first quarter adopted by the global body of bank regulators—the Basel Committee on of 2020 resulted in a flight to safety and widening spreads on bond yields Banking Supervision—in late 2017. Some additional policy work remains, of developing countries. Countries should explore coherent, integrated but most attention has now turned towards implementation of the policy frameworks that bring together monetary, exchange rate, reforms. Despite progress, implementation of the reforms is not complete macroprudential, capital flow management, and other policies as part and remains uneven.1 of integrated national financing frameworks (INFFs) to manage excess leverage and volatility in domestic and cross-border finance. Effective Large banks are better capitalized, less leveraged and hold more liquidity use of these policies can increase policy space and reduce the need of (figure III.F.1). Implementation of two standards—the leverage ratio and countries to resort to emergency financing from the global financial safety net stable funding ratio—were late in a limited number of jurisdictions, net. Meanwhile, Member States of the United Nations need to work to fill as both were to be implemented in 2018 (figure III.F.2). The supervisory gaps in the global financial safety net, with stronger regional financial framework for measuring and controlling large exposures, which took arrangements where they are insufficient. effect in January 2019, has been adopted by 10 FSB member jurisdictions, with the remaining 14 not having final rules in place. Finally, Member States should consider whether governance arrangements at various international institutions need further reform, Steps have been taken to address financial institutions that are considered especially those that have not undertaken reforms in many years. The am- too big to fail (TBTF). All developed countries now require that global bitious 2030 Agenda requires institutions that allow careful consideration systemically important banks (G-SIBs) meet targets for external total 2 of coherence and coordination. This Task Force has become a mechanism to loss-absorbing capacity (TLAC). Nevertheless, TLAC is just one part of improve inter-agency coherence. the regulatory and supervisory framework that contributes to preventing insolvency. More work is still needed to operationalize resolution plans for This chapter is divided into three sections: the first discusses international TBTF institutions for when they fail. standards of financial regulation, including the implementation and impact of regulatory reforms taken after the 2008 world financial and Insurance industry supervisory reforms, such as creating effective economic crisis; the next section discusses macroeconomic management resolution regimes, are less advanced, while the sector is also facing new and crisis response; and the final section discuss how to strengthen global challenges from climate change. The majority of FSB jurisdictions do not governance. have in place comprehensive insurance resolution regimes. The identification of global systemically important insurers (G-SIIs) has remained suspended since 2018 while the International Association of Insurance Su- pervisors develops a comprehensive framework to try to mitigate systemic 2. International standards of risk in the insurance sector. financial regulation Derivatives markets have been another focus of regulators. The markets Although financial regulation is generally a national responsibility, as the are now simpler and more transparent, although additional progress since world has become increasingly integrated financially, regulation is best 2018 has been limited. Standardized clearing of over the counter deriva- performed in an internationally coordinated manner to prevent regulatory tives transactions through central counterparties (CCPs) is a pillar of the arbitrage. Since the 1970s, an increasing number of national regulators reform. It important to further strengthen the resilience and resolvability have met to agree on common regulatory standards, which individual of CCPs. There has also been progress on reporting of derivatives trading countries then implement to a greater or lesser degree. Banking regulation to trade repositories (TRs), though challenges include a lack of globally 3 has been strengthened since the 2008 world financial and economic crisis. harmonized data, uneven data quality, and access to TR data. 4 Achieving the Sustainable Development Goals will require a shift towards Regulation of non-bank financial intermediaries (NBFIs), including long-term investment and sustainability as a central concern of investment structured finance vehicles, investment funds, money market funds, decisions (see chapter III.B). Such a shift demands aligning private and hedge funds, broker-dealers, trust companies, and other non-bank and public incentives with sustainable development. Traditionally, financial non-insurance lenders, has also been on the FSB agenda. These entities regulation focused on safety and soundness of the financial sector. In the currently bear a greater share of financial risk (see chapter I) and can be Addis Ababa Action Agenda, Member States agreed to “work to ensure important connectors that spread risk and volatility to other parts of the that our policy and regulatory environment supports financial market financial system. stability and promotes financial inclusion in a balanced manner”. Financial FSB members have adopted an internationally agreed NBFI monitoring regulation must still aim at reducing systemic financial risks; however, all framework and have advanced regulatory standards on two components

142 ADDRESSING SYSTEMIC ISSUES

Figure III.F.1 Bank capital and liquidity provisions, 2012–2018 (Ratio, percentage) 160 14

140 12

120 10

100 8 80 6 60

4 40

20 2

0 0 H2 2012 H1 2013 H2 2013 H1 2014 H2 2014 H1 2015 H2 2015 H1 2016 H2 2016 H1 2017 H2 2017 H1 2018 H2 2018

Liquidity coverage ratio (c) Net stable funding ratio (d) CET1 Capital ratios (Right) (a) Leverage ratios (Right) (b)

Source: BCBS. Note: (a) 81 banks, (b) 63 banks, (c) 69 banks and (d) 85 banks

Figure III.F.2 Progress of regulatory reform implementation, 2019 (Percentage of FSB member jurisdictions)

Progress of regulatory implementation

Securitization nancial nancial

Non-bank Money market fund regulation intermediation intermediation

Resolution powers

Recovery planning for SIBs regimes

Resolution planning for SIBs E ective resolution

Leverage ratio el III

Bas Net stable funding ratio implementation

0 10 20 30 40 50 60 70 80 90 100

Final rule in force Final rule or draft regulation published Draft regulation not published

Source: FSB. Note: For systemically important banks (SIBs), the six European Union members of the FSB are presented as separate jurisdictions. 143 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

of the universe: money market funds and issuance of asset-backed securi- banking system, large banks are better capitalized, less leveraged and ties. Implementation of money market fund standards is most advanced hold more liquidity than prior to the crisis. A remaining risk factor in the in the countries hosting the largest markets for these funds. Measures to banking sector is the growth of systemically important banks’ share of better align the incentives of institutions issuing asset-backed securities global banking assets, which has increased in recent years as the large with the risks embedded in the securities have been implemented in the banks continue to become ever larger and more complex.6 This jurisdictions issuing the vast majority of them, where issuers are obliged reemphasizes the importance of work to operationalize resolution plans to (directly or indirectly) retain typically 5 per cent of the credit risk of (see section 2.1). The FSB is in the process of evaluating the effects of TBTF the securitization.5 However, new products with similar risk profiles are reforms for systemically important banks, and will launch a public continually developed, and application of the risk-retention rules to dif- consultation in June 2020. ferent product categories is not uniform. For example, in one systemically important country, while a bank creating a collateralized loan obligation Table III.F.1 (CLO) from its own portfolio of leveraged loans would be subject to risk Classification by economic function for monitoring NBFIs retention, an open market CLO which is created by a third party would not Definition Typical entity types be subject to the 5 per cent risk-retention rules. EF1 Management of collective investment Money market funds, fixed income vehicles with features that make them funds, mixed funds, credit hedge funds, Implementation of reforms in other policy areas is at an earlier stage. susceptible to runs real estate funds Vulnerabilities in asset management are the subject of ongoing standards EF2 Loan provision that is dependent on Finance companies, leasing/factoring, implementation by securities regulators through the International Orga- short-term funding companies, consumer credit companies nization of Security Commissions (IOSCO). IOSCO and the FSB will assess if EF3 Intermediation of market activities that Broker-dealers, securities finance these recommendations have been implemented effectively by mid-2021 is dependent on short-term funding or companies and the FSB will report back to the G20. on secured funding of client assets EF4 Facilitation of credit creation Credit insurance companies, financial 2.2 Impacts of reforms and risk factors guarantors, monolines EF5 Securitization-based credit intermedia- Securitization vehicles, structured Total global financial assets have continued to increase since the global tion and funding of financial entities finance vehicles, asset-backed securities financial crisis (figure III.F.3). As noted in chapter I, risk in the financial Source: FSB. sector has declined since the global financial crisis, while risk may have Note: The entity types listed should be taken as typical examples, not a increased in NBFIs during the period of high global liquidity. Within the comprehensive list.

Figure III.F. 3 Assets of nancial intermediaries, 2004–2018 A. Total global nancial assets B. Share of total global assets (Trillions of United States dollars) (Percentage of total assets) 160 50

140 45 40 120 35 100 30 80 25

60 20 15 40 10 20 5 0 0 2004 2006 2008 2010 2012 2014 2016 2018 2004 2006 2008 2010 2012 2014 2016 2018

Banks Central banks

Public nancial institutions Insurance corporations

Pension funds Other nancial intermediaries (OFIs)

Source: FSB. Note: Based on 21 jurisdictions plus the Euro area; banks includes all deposit-taking corporations; share of total calculated as a weighted average based on total national nancial assets.

144 ADDRESSING SYSTEMIC ISSUES

Box III.F.1 Impact of regulatory reform on small and medium-sized enterprise financing In November 2019, the Financial Stability Board (FSB) published an evaluation of the effects of financial regulatory reforms on financing of small and medium-sized enterprises (SMEs) in FSB jurisdictions.a The evaluation was motivated by the need to better understand the effects of the reforms on the financing of real economic activity and their contribution to the of the Group of Twenty (G20) objective of strong, sustainable, balanced and inclusive economic growth. Given that banks are the primary providers of external SME financing, the most relevant reforms implemented to date are the initial capital and liquidity requirements agreed in 2010 (Basel III). These have been evaluated using both qualitative and quantitative analysis; other relevant reforms that are at an earlier implementation stage or that are national or regional regulations were only analysed qualitatively, consistent with the FSB evaluation framework. The evaluation found no material or persistent negative effects on SME financing in general, although there was a degree of differentiation across jurisdictions. Some evidence showed that the more stringent risk-based capital requirements under Basel III slowed the pace and, in some jurisdictions, tightened the conditions of SME lending at those banks that were least capitalized ex ante relative to other banks. These effects were not homogeneous across jurisdictions and they were generally found to be temporary. The evaluation also provides some evidence for a reallocation of bank lending towards more creditworthy firms after the introduction of reforms, but this effect is not specific to SMEs. SME lending has grown in recent years, although volumes remain below the pre-crisis level in some jurisdictions. Access to external finance for SMEs also appears to have improved, particularly in advanced economies. Stakeholder feedback suggests that SME financing trends are largely driven by factors other than financial regulation, such as public policies to address SME financing constraints and macroeconomic conditions. Any potential costs found in this evaluation need to be framed against the wider financial stability benefits of the G20 reforms estimated in ex ante impact assessments. These studies generally found significant net overall benefits in terms of reducing the likelihood and severity (lost output) of financial crises. a Financial Stability Board, “Evaluation of the Effects of Financial Regulatory Reforms on Small and Medium-Sized Enterprise (SME) Financing: Final Report” (Basel, Financial Stability Board, November 2019). Available at https://www.fsb.org/2019/11/evaluation-of-the-effects-of-financial-regulatory-reforms-on-small-and- medium-sized-enterprise-sme-financing-final-report/.

Overall, the share of assets in banks fell to 39 per cent (or $148 trillion), sandboxes in both developed and developing countries—that would be while the share of assets held by NBFIs grew (figure III.F.3). This reflects valuable to share. One lesson is to develop regulations focussed on the average annual growth of a narrow measure of NBFIs of 8.5 per cent from function actors are performing rather than on the type of institution. 2012-2017 (the narrow measure compiles data on NBFIs that are involved in The FSB is continuing to conduct evaluations on different aspects of the five types of credit intermediation activities that may pose bank-like finan- reforms. The next evaluation, to be completed by end-2021, will be on cial stability risks (table III.F.1)). In 2018, growth significantly slowed, to 1.7 the effects of money market fund reforms. These studies are intended per cent year on year, reaching $50.9 trillion in 2018, and representing 13.6 not only to monitor the impact of FSB reforms, but also identify possible per cent of total global financial assets.7 In 2018, assets of other financial unintended effects of the reforms. One such evaluation was completed intermediaries (one component of NBFIs) declined for the first time, mainly in 2019 on the impact of the reforms on the access to finance of small and as the result of stock market declines towards the end of the year and, to a medium-sized enterprises (SMEs) (box III.F.1). lesser extent, outflows from certain subsectors.8 A 2017 FSB assessment concluded that those aspects of the non-bank intermediation that contributed to the 2008 global financial crisis, includ- 2.3 The growth of digital currencies ing various forms of structured finance (e.g., sub-prime mortgage-backed Digital currencies have thus far been a minor phenomenon in global securities), have declined significantly and generally no longer pose finance, despite being a source of significant hype and media atten- financial stability risks. However, there are new instruments and evolving tion. There are three types of digital currencies: crypto-assets, so-called market structures, such as leveraged loans, which have grown significantly “stablecoins”, and central bank digital currencies. Chapter II discusses since the crisis. As noted in chapter I, 80 per cent of new leveraged loans their benefits but also notes that as these technologies advance, their issued in the United States of America are “covenant-lite”—that is, they application has the potential to be a source of systemic risk. Yet the risks have fewer protections for lenders. In addition, new financial technologies and benefits differ significantly based on the type of instrument, backers (fintech) are blurring the lines between software, payments and credit and design. intermediation (see chapters II and III.G). These innovations are making positive contributions to sustainable development, but could create Crypto-assets systemic risks, particularly in countries where fintech has a high penetration (often coinciding with underdeveloped financial institutions and Currencies are typically defined as having three functions: a store of value, weak regulatory capacity). The challenge for policymakers is to regulate a unit of account, and a medium of exchange. While proponents argue these risks without stifling innovation (see chapter II). There is growing that crypto-assets can be substitutes for currencies issued by central banks, experience in regulating these innovations—including through regulatory no crypto-asset serves these three functions reliably to date. Excessive 145 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

volatility is a key reason preventing such assets from fulfilling the func- messages, so-called mobile money, or via mobile phone apps or mobile tions of money. wallets, such as Apple Pay or Alipay. Mobile money is still usually backed Most crypto-assets rely on distributed ledger technology, which means by cash, meaning it is available to consumers without bank accounts, that there is no one central authority that keeps track of the balances. while apps and wallets are tied either to card-based payment networks or Instead, this information is distributed among all users in the system. directly to bank accounts. These innovations can bring benefits in the form Some crypto-asset promoters suggest that decentralized payment process- of financial inclusion and faster, cheaper payments operations. ing could bring greater efficiency and speed to international transactions, A new proposal, which has not yet been implemented, is issuance of which currently rely on correspondent banking relationships. Yet, this private digital tokens using the distributed ledger technologies that under- decentralized nature of crypto-assets, combined with anonymity and gird other crypto-assets. This is the design of the libra, a global stablecoin, cross-border reach, also raises concerns around illicit finance. Currently, proposed in June 2019 (box III.F.2). Unlike earlier efforts, which facilitated bitcoin and other crypto-asset transactions cannot be authoritatively payments through the banking system, this new type of network would be traced to real identities due to anonymizing service providers, and there is outside the well-regulated parts of the financial system. As the proponents evidence that crypto-assets have proven fertile ground for financial crimes plan to tie the value of the tokens to a single currency (or a basket of (see chapter III.A). Crypto-assets have also facilitated the retail trade in currencies) backed by a reserve fund of liquid assets, they have given the illicit drugs through anonymous marketplaces. token the name “stablecoin”. Such a global stablecoin could come much In October 2018, the Financial Action Task Force (FATF) updated its closer to fulfilling the functions of a currency. standards and recommendations regarding crypto-assets. It defined a In addition to the efficiency and potential inclusion benefits of the new group of “virtual asset service providers” and called on jurisdictions electronic systems discussed above, stablecoins could provide lower to include these providers in anti-money laundering and countering the cost and faster cross-border payments. Moreover, payments could be financing of terrorism (AML/CFT) regulations. This challenges their suit- easier because they could be embedded into digital applications that ability to replace correspondent banking, where the loss of relationships is many people already use. There are, however, a plethora of operational often due to the costs of compliance with AML/CFT regulations. and consumer protection risks associated with stablecoin proposals that To date, most crypto-assets have been traded on underregulated exchanges and used as speculative assets. The 2019 Financing for Sustain- able Development Report highlighted evidence on the high frequency of Box III.F.2 fraudulent activity related to initial coin offerings as well as concerns of The Libra Association and libra token market manipulation on crypto-asset exchanges. However, due to their In June 2019, Facebook, the world’s largest social media network, limited reach they do not currently represent a material risk to financial and other financial sector and digital business partners announced a stability. joint initiative under the umbrella of the Libra Association to create a new global so-called “stablecoin” called libra that could be used Payment services and stablecoins like a currency. The association proposed to stabilize the value of the As noted in chapter II, payment systems and the ability to send and libra against a basket of currencies, keeping a reserve of liquid assets receive payments across borders are the backbone of the financial system. with full backing for every libra token created. The libra is meant to Recognizing the importance of efficient and inclusive payment services for promote financial inclusion, allow easier movement of money glob- global growth, the FSB will coordinate the development of a road map for ally, and secure digital financial assets on mobile devices through use improving cross-border payments to be delivered to the G20 in October. of distributed ledger technology. A number of interbank and payments processing systems have existed Because the major backers already have large user bases, libra for decades (e.g., card-based retail electronic domestic and cross-border presented concerns of a different order of magnitude than previous payment systems operated by companies such as Visa and Mastercard, crypto-asset and fintech innovations. While the project is still being who dominate the developed-country market). Interbank (or wholesale) developed, the Association is facing challenges. Major payments pro- payments are most frequently handled by the correspondent banking cessors, including Visa and Mastercard, and some major e-commerce network which relies on the Society for Worldwide Interbank Financial websites, which had been original backers of the Libra Association, a Telecommunication (SWIFT) network—a cooperative payments messag- decided to withdraw from the group in October 2019. There are also ing utility, set up in 1973 by 239 banks from 15 developed countries. More regulatory hurdles, as a number of jurisdictions have indicated that b recently, payment services in some developing countries, often established they would not authorize use of the libra. jointly by Governments and the banking sector, have sought to capitalize a Visa, “Visa Statement on Involvement in the Libra Association”, on their rapid domestic growth by developing cross-border networks and October 11, 2019. Available at https://usa.visa.com/visa-everywhere/ blog/bdp/2019/10/11/visa-update-1570828991831.html; Mastercard, partnerships, such as those pursued by UnionPay (China) and RuPay (India). “Mastercard’s Principles for Blockchain Partnerships”, October 16, 2019. These payments systems are bank-based and thus integrated with the Available at https://newsroom.mastercard.com/news-briefs/mastercards- well-regulated parts of the financial system. principles-for-blockchain-partnerships/. b Bundesfinanzministerium, “Joint Statement on Libra”, September 13, Some private actors have argued that these systems are too slow or 2019.Available at https://www.bundesfinanzministerium.de/Content/EN/ outdated. New technology innovations on the retail side are bringing Standardartikel/Topics/Financial_markets/Articles/2019-09-17-Libra.html. more speed and efficiency to consumers by allowing payment with text 146 ADDRESSING SYSTEMIC ISSUES should be addressed by regulators.9 First, distributed ledger technology CBDC design choices include (i) how open the payment network is; (ii) the uses significantly more energy in the processing of transactions, creating degree of anonymity of users and traceability of transactions; (iii) the abil- potential climate risks. Second, similar to crypto-assets discussed above, ity to earn interest; and (iv) the immediacy of settlement.16 stablecoins could facilitate greater illicit financial flows, especially if A CBDC has similarities to private stablecoins, but also has unique charac- money-laundering regulations are not implemented. Third, private teristics because it is tied to the central bank.17 For example, if a central stablecoins, if successful, could have implications for macroeconomic bank designed its CBDC to provide account-based digital currencies directly policies and financial stability in both developed and developing coun- to individuals, those people may have lower incentives to use a private 10 tries. The reserve backing could retain large volumes of the world’s commercial bank for ordinary deposits. This could reduce the role of private money supply, with potential implications for the reserve currency banks in financial intermediation, which would likely increase banks’ fund- issuers. Developing countries could face a particular challenge, given ing costs. This disintermediation could impact the availability of capital for the potential ease with which their residents could store their financial productive investment and could incentivize a shift from debt-based fi- assets in stablecoins, rather than in the local banking system. Stablecoins nancing to equity financing, fundamentally changing the financial system. could severely hamper the ability of central banks to effectively transmit Some have argued that crypto-asset-based banks might emerge, but also monetary policy changes to the economy, increase capital flow volatility that such banks would likely have different risks and need different types and facilitate instantaneous capital flight whenever confidence begins to of regulation.18 A central question is who ultimately holds the risk of ebb in the domestic currency. Proponents say that this would put pressure financial intermediation. For example, a central bank account-based CBDC on Governments to enact better policies, but as with any herd behaviour could, depending on the design characteristics and regulations, put the of investors, this could cause self-fulfilling prophecies and wild swings in central bank in the intermediation chain between depositors and lenders, exchange rates, which can precipitate financial crises, which impact the meaning some risk concentration in the central bank. Alternative designs real economy. could mean that individuals hold all the risk (see chapter II). Central banks An effective regulatory and supervisory approach to stable coins needs are currently studying the potential effects of such a shift, as well as alter- to be able to identify, monitor and address potential risks in a reasonable native models, and should be carefully considering the designs of CBDCs to range of scenarios and uses. The United Nations General Assembly has address risks of different models of financial intermediation. already urged regulators to carefully consider the potential implications Countries may not need a CBDC to go cashless. In many countries, existing for the international and domestic financial system when formulating bank-based electronic payment systems can be scaled up to meet demand. the appropriate regulatory treatment for crypto-assets and stablecoins In general, policymakers need to develop the design of a CBDC with regard in their jurisdictions.11 FATF will report to the G20 in 2020 on the to the existing institutions and economic, social, and even environmental money-laundering and terrorist financing risks from global stablecoins conditions of a country. and other emerging assets. The FSB will publish a consultation paper on addressing regulatory issues of stablecoins in April 2020, and a final report, which will be delivered to G20 Finance Ministers and Central Bank Gover- 2.4 Financial policy interaction with climate change nors, in July 2020. The International Monetary Fund (IMF) will produce a The Addis Agenda brought environmental and social issues into the paper for the G20 on the macroeconomic implications, including monetary discussion on the coherence and consistency of international policies and sovereignty issues, of stablecoins. institutions. Since 2015, concerns about climate change have intensified, as evidence shows increased climate instability and frequency of Central bank digital currencies weather-related disasters, as well as rising economic losses from them. In 2019, the Task Force highlighted the need for the regulatory system Central banks representing a fifth of the world’s population say they are to be congruent with measures to boost the sustainability of the private likely to issue the first central bank digital currencies (CBDCs) in the next financial system. Since then, there has been increased focus on macroeco- few years, with greater interest from developing countries.12 CBDCs would nomic and financial risks posed by climate change, and the potential role be a digital form of national fiat money, intended to be used as legal tender of central banks and financial regulators.19 As discussed in chapter III.B, similar to cash, and that could possibly completely replace cash in the future. the relationship between climate risk and finance is defined by two related One of the main benefits of a CBDC, or any cash-free system, would be to issues: (i) the impact of climate risks on financial stability; and (ii) the reduce the costs of producing cash. Estimates of the costs of maintaining impact of financial investments on climate risks. the cash system range from 0.3 to 0.7 per cent of gross domestic product for developed countries,13 although these costs can only be eliminated if an Climate risk as financial and macroeconomic risk economy goes entirely cashless. Another benefit of a CBDC could be greater Markets are beginning to realize that climate risk is financial risk. The risks traceability of transactions, which can assist in combatting illicit financial stem both from physical risks to assets and operations, and transition risks 14 flows as well as potentially increase the tax base. A principal consider- related to changes of policies to address climate change. Indeed, in 2019 ation for central banks should be financial exclusion, as public interventions the first S&P 500 firm20 declared bankruptcy due to the effects of climate may be needed to assist those without access to the requisite technology. change. As risks grow from impacts on individual firms to risks to the Two main types of CBDC are being explored: token-based (similar to cash) broader economy and financial system, a critical question is how central and account-based (similar to commercial bank accounts). The difference banks and financial regulators should react. The FSB announced that it will hinges on the method of authenticating the validity of payment.15 Other examine the financial stability implications of climate change in 2020.

147 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Generally, central banks and regulators have two avenues to ex- regard to climate change is the extent to which it will ultimately impact plore. First, they can continue to work with voluntary approaches these objectives. As a further step beyond monitoring and assessing risk, and industry-promoted good practice standards. The Task Force on it is possible for central banks and financial regulators to take a more Climate-related Financial Disclosures (TCFD) was established by the FSB in active role. Indeed, the second recommendation of the NGFS call to action December 2015 to develop a set of voluntary, consistent disclosure recom- mentioned above, on integrating sustainability into central banks’ own mendations for use by companies in providing information (see chapter portfolio management, begins to go in this direction. Since the 2008 III.B). However, a June 2019 TCFD survey found that while disclosure is financial crisis, developed-economy central banks have accumulated large increasing, it is insufficient. In particular, the majority of companies do not portfolios of assets through quantitative easing. Some central banks have disclose sufficiently clear information on the potential financial impact sufficiently large asset bases that concerted efforts to price climate risk of climate-related issues nor on the resilience of their strategies. The in their own portfolios can potentially induce market-wide shifts in asset FSB asked the TCFD to clarify guidance for reporting on business relevant pricing. The NGFS also encourages regulators to develop a classification climate-related scenarios and to deliver another status report to the FSB in system to identify which economic activities contribute to the transition to November 2020. a green and low-carbon economy. Second, central banks, financial regulators and other policymakers are Financial authorities have many options at their disposal, some more considering other measures beyond voluntary disclosures of private tested than others.24 Policies that have been proposed include green firms. These may be needed, for example, to reflect the increased risk quantitative easing; collateral frameworks and credit allocation policies of non-performing loans due to stranded assets (see chapter III.B). The that take climate change into account; and direct financial incentives. In Network for Greening the Financial System (NGFS)—an association of the realm of unconventional monetary policy interventions, such as the 55 central banks and supervisors including those from almost all G20 quantitative easing programme, central banks could either screen out countries—seeks steps in that direction, starting with support for better brown or carbon-intensive assets from bond purchases, or directly subsi- assessment of risks and opportunities associated with climate change. It dize specific sectors of the economy by directing bond purchases to assets recommends including climate risk in stress tests for the banking sector with certain environmental standards. or, at a minimum, lengthening the timeframe of existing stress tests to Sustainable development, including climate risk, could also be integrated include long-term risks. Similarly, the IMF is working on incorporating into financial regulations beyond addressing the climate-related financial 21 climate risk in macro-financial stress testing. risk discussed above. International standard-setting bodies set minimum In April 2019, the NGFS published its first comprehensive report, proposing prudential standards commensurate to risk, aiming to promote global four recommendations to coordinate the efforts of central banks, supervi- financial stability and prevent financial regulatory competition. Higher sors and the financial sector: (i) integrate monitoring of climate-related standards than the minimum can be applied, per national (or regional) financial risks into day-to-day supervisory work, financial stability moni- discretion. In 2018, the EU High-level Expert Group on Sustainable Finance toring and risk management by boards; (ii) encourage central banks to lead suggested that sustainability be incorporated directly into the capital by example and integrate sustainability into their own portfolio manage- requirements of regulated financial institutions. Some countries have also ment; (iii) collaborate to bridge data gaps to enhance the assessment of taken measures to encourage financial institutions to increase credit avail- climate-related risks; and (iv) build in-house capacity and share knowledge ability to green sectors and promote the growth of sustainable finance. with other stakeholders on the management of climate-related financial As an alternative to unilateral changes in prudential standards, climate risks.22 Important streams of work, as discussed in chapter III.B, are change-related standards could be incorporated into the Basel capital ad- harmonizing corporate disclosures on climate-related issues and agreeing equacy framework, or in parallel green asset minimums,25 so that there is on standards for defining the “greenness” of business activities. no weakening of prudential regulation. Analytical work on defining “green” Climate-related risks can be particularly acute for the insurance sector due and “brown” assets according to climate-related financial risk exposure, to the increasing frequency and intensity of disasters, particularly if insur- and quantifying the impact these might have on loan quality and financial ance firms have concentrated risk in certain economic sectors or regions. stability, could support this effort (see chapter III.B). Indeed, some insurance companies have been in the lead on efforts to price Macroprudential measures, a policy tool to mitigate system-wide climate-related risks.23 At the same time, big data is helping insurance risks, could also be adapted for use in this area. An example of a companies better determine risk probabilities and price risk. This is leading financial-stability-oriented, macroprudential tool is loan-to-value require- to the development of new insurance products, but is also leading to con- ments on mortgages based on system-wide indicators on housing prices. cerns of financial exclusion, where those that most need insurance might Similarly, supervisors could adopt loan-to-energy-efficiency benchmarks or be priced out of the market (see chapters II and III.B), raising the need for requirements for mortgage portfolios, which could be used to incentivize public support. Efforts to develop a comprehensive framework to try to banks to include energy efficiency retrofit requirements into mortgages. mitigate systemic risk in the insurance sector will need to pay attention to Some countries have already issued guidelines for greening their financial the financial risks from climate change. systems which include combinations of guarantees, subsidies, environmental risk management rules, green standards for credit rating, and Financial policies to slow climate change macroprudential measures.26 To fully incorporate climate change in finan- Central bank monetary policy mandates generally focus either solely on cial policies, policymakers may consider further clarifying the mandates price stability or on price stability and other socioeconomic factors, such provided to regulators and central banks so that they cover all dimensions as employment. Thus, for many central banks, the primary question with of sustainable development. 148 ADDRESSING SYSTEMIC ISSUES 3. Macroeconomic management 3.1 Prudent macroeconomic management Cross-border capital flows can provide significant benefits, such as and crisis response improving access to funding; however, capital flows—particularly when Chapter I discusses how international financial spillovers—a conse- large and volatile—may also threaten financial stability, especially in the quence of unconventional monetary policies and prolonged low interest small, open economies of many developing countries. Risks are greater in rates in major developed economies—raises concerns, including on the presence of underlying macroeconomic or financial vulnerabilities, but capital flow volatility. Prior to the onset of the crisis, net capital flows to the risks exist in all countries. For example, non-economic factors, such as developing countries, in aggregate, were already expected to return to the spread of COVID-19, can lead to capital flight from affected countries 27 negative territory in 2019 (figure III.F.4), although this is due to the effects or even broader flight to safety. While policymakers should be ready of just one region (East Asia) (figure III.F.5). However, higher demand for to respond to new developments such as a pandemic or disaster, they can dollar liquidity following the global shutdowns as a response to COVID-19 also consider introducing policies before crises arrive, so that they have a led to an unprecedented shock to capital flows to developing countries wider variety of tools and instruments at their disposal. in the first three months of 2020. Cumulative outflows from late January Many countries have adopted flexible exchange rate regimes that broadly through March of 2020 surpassed the levels documented at the peak of follow the “textbook” prescription to allow exchange rates to adjust the 2008 global financial crisis, indicating the largest capital outflows freely in response to capital flow swings. That frees monetary policy to ever recorded. According to latest figures by the IMF, investors have focus on domestic cyclical conditions in the spirit of a “one target – one removed around $83 billion from emerging markets since the start of instrument” approach. However, large swings in the exchange rate can be the crisis. disruptive to the real economy as they change domestic prices of exports International capital markets can transmit volatility and instability and imports relative to non-traded goods and services. It can also raise the across borders, even when countries have sound national frameworks. In cost of external debt servicing relative to domestic revenues, sometimes this context, countries should approach strengthening policymaking in a precipitating a debt crisis. Many countries thus deviate from the textbook risk-informed and integrated manner. Integrated policy frameworks, framework in a variety of ways. Central bank intervention in foreign which bring together appropriate combinations of different macroeco- exchange markets to influence exchange rates is fairly prevalent, particu- nomic management policies, can be part of broader country larly among emerging market economies, and particularly in response to development strategies. The international community has created and persistent capital inflows. periodically upgraded a global financial safety net (GFSN) to assist Some Governments have adopted macroprudential measures, which aim countries with supplementary financing when national frameworks are to contain systemic risks by smoothing cyclical swings in domestic credit insufficient. availability. As a by-product they can also smooth “booms” and “busts” in

Figure III.F.4 Net nancial ows to countries in developing regions, 2008–2019 (Billions of United States dollars) 1 000

800

600

4 000

200

–200

–400

–600 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Total net ows Direct investment, net Portfolio investment, net Other investment, net Change in reserves

Source: IMF, World Economic Outlook (October 2019). Note: Positive values denotes a net in ow of capital and an increase in reserves. A negative value indicates a net out ow of capital and a decline in reserves. 2019 value is a projection.

149 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Figure III.F.5 Net nancial ows, by region, 2007–2018 (Billions of United States dollars) 400

300

200

100

–100

–200

–300

–400

–500

–600 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Africa South & East Asia Economies in Transition West Asia Latin America and the Caribbean

economic activity. For example, capital requirements of banks can be in- This rich variety of policy options points to the importance of national creased in boom times to discourage rapid credit growth and eased during planning in this area. The IMF has put forward the concept of an integrated economic slowdowns to encourage banks to lend more, so that macropru- policy framework (IPF) that draws on the host of alternatives to formu- dential measures are used to smooth the domestic business cycles. Some late the best policy set to meet different countries’ needs. An IPF would of the measures are discretionary, while others establish rules for policy consider the role of monetary, exchange rate, macroprudential and capital change. Impacts on different economic sectors, including cross-border flow management policies, and their interactions with each other and activity of banks, can also differ. In some instances, macroprudential poli- other policies. The policies considered in the IPF should be components cies may be more effective than using monetary policy, as macroprudential of a country-owned strategy within an integrated national financing measures can focus exclusively on smoothing the domestic business cycle, framework (INFF), as laid out in the 2019 Financing for Sustainable Develop- while use of monetary policy can stimulate or discourage capital inflows. ment Report. The country plans would aim to provide a more systematic Overall, these policy options aim to target vulnerabilities and comple- approach to designing an effective macroeconomic policy mix to pursue ment social protection systems and other domestic policies that promote growth and stability objectives, attuned to country-specific circumstances. 28 resilience in the event of shocks. The IMF is working to develop tools to provide more nuanced guidance Governments also use measures from another class of policy tools known and advice to Member States on how to design integrated policies, using as “capital flow management measures”. These measures come in a variety modelling, empirical work, and case studies. The case studies seek to of types, including quantitative outflow restrictions, non-interest-bearing identify patterns in country behaviour. Cross-country empirical analysis reserve requirements for financial inflows, taxes on inflows and/or out- explores whether these insights generalize, helping to select key features flows, or outright bans. The various measures have differing impacts and and parameters for models that closely match country conditions on the consequences, both intended and unintended.29 ground. Ultimately, the work should also result in the IMF having a more Preliminary studies suggest that the textbook approach is likely better suited nuanced approach in its own assessments in its annual Article IV consulta- 30 for countries with deep foreign exchange markets in the absence of severe tions with member countries. currency mismatches. On the other hand, foreign exchange intervention and/ or capital flow management measures may dampen capital flow volatility 3.2 Global financial safety net and thus support output stabilization in countries with large balance sheet At a time of high uncertainty and rising downside global risks, it is critical mismatches and relatively shallow foreign exchange markets, particularly that Member States take action to strengthen the permanent international if a large share of that country’s exports is invoiced in foreign currency. That financial safety net, as committed in the Addis Agenda. Member States said, frequent exchange rate intervention may reduce the perception of risk have called for a strong, quota-based, and adequately resourced IMF at by the private sector and lead to an accumulation of vulnerabilities. the centre of the GFSN. Taking account of the challenges posed by higher

150 ADDRESSING SYSTEMIC ISSUES interconnectivity and uncertainty in the global economy, all layers of between September 2011 and December 2017 were successful or partially the GFSN—countries’ own international reserve buffers, bilateral swap successful in achieving their objectives, such as resolving balance-of- arrangements (BSAs), regional financing arrangements (RFAs) and the payment problems and fostering economic growth. With a view to raising IMF—have expanded substantially since the 2008 global financial crisis. the rate of success, the Fund agreed its staff would bring “more realism, Nevertheless, gaps in the GFSN remain, including the need to strengthen granularity, gradualism and parsimony in programmes, as well as sharper collaboration between the IMF and RFAs and the availability of appropri- debt sustainability analyses to mitigate any bias in judgment and ensure ate financing instruments. The IMF Executive Board has also noted “many more balanced consideration of debt (and debt restructuring) operations, countries do not have reliable access to BSAs or RFAs”.31 where warranted.”33 IMF loans to low-income countries (LICs) are provided on concessional terms Regional financial arrangements and are financed by member Governments. The IMF lends to LICs through RFAs have become an important component of the GFSN, prominently in three facilities—loans which are currently provided at zero interest and Europe, Asia and Latin America. The IMF is enhancing cooperation with subsidized through the Poverty Reduction and Growth Trust (PRGT), which is RFAs to increase the effective firepower of the GFSN and ensure a timely financially self-sustainable as income from investments of the trust cover the and coordinated deployment of resources, as called for in the 2017 IMF subsidy costs of the concessional lending. To maintain the viability of the trust Executive Board paper on collaboration between RFAs and the Fund. The fund, there are limits on the size of PRGT-subsidized loans. Debt relief for the framework lays out modalities for collaboration across capacity develop- poorest and most vulnerable countries hit by catastrophic natural or public ment, surveillance and lending, and forging operational principles to help health disasters is financed by the Catastrophe Containment and Relief Trust. guide co-lending by the Fund and RFAs so as to ensure it is done cohesively. The IMF reviewed its facilities for LICs in 2018 and in May 2019 its Board These principles include seeking early and evolving engagement, the ben- endorsed a set of reforms, beginning with a one-third across-the-board efit of exploiting complementarities, the criticality of a single programme increase in LIC borrowing limits from the Fund, with a further increase in framework, and the need for mutual respect of institutional independence some cases to better support countries affected by conflict or disasters. In and capacity. In 2018, the IMF also amended its policy framework for the the light of limits to available subsidy funds, access to subsidized loans was exchange of documents, allowing greater exchanges between the Fund tilted towards the poorest countries, with expanded blending of conces- and RFAs to help ensure timely information-sharing. sional and non-concessional financing for higher-income LICs that enjoy In line with its framework, the IMF has participated in several “test runs” access to international financial markets. In addition, the key lending in- with the Chiang Mai Initiative Multilateralization (CMIM) since 2017. These strument (the Extended Credit Facility) was modified to (i) allow for longer exercises improved the operating procedures of the CMIM and its coordina- programmes in countries seeking support for medium- and longer-term tion with the Fund, which will facilitate future co-financing operations structural reform; and (ii) make clear that programmes in post-conflict should they become necessary. The IMF is also working to deepen col- countries with high uncertainty and low capacity should focus initially on laboration with other RFAs and refine the modalities of how best to work a streamlined set of near-term reforms that support economic and political together, including via similar test-run exercises. stabilization. Finally, the reform promised heightened attention to debt sustainability and transparency through strengthened safeguards for 34 IMF resources and facilities countries warranting “high” and “exceptional” loan access. The Fund is currently adequately resourced, with an overall lending capacity of about $1 trillion. Almost half of this capacity consists of permanent 4. Strengthening global governance IMF quota resources. Quotas are the building blocks of the IMF financial and governance structure and have four roles: resource contributions, Global governance has changed significantly since the turn of the century, voting power, access to financing, and special drawing rights (SDR) as the 2008 global financial crisis prompted multilateral coordination on a allocations. The remainder of IMF lending capacity consists of borrowed scale not previously witnessed. Yet, recently there has been some retreat resources that the Fund may draw upon from member countries in case of from multilateralism which could make responses to any global financial need under the New Arrangements to Borrow (NAB) and Bilateral Borrow- and economic crisis more challenging. The international community has ing Agreements (BBA). In October 2019, IMF members endorsed a package struggled with how to strengthen global governance and make it more on IMF Resources and Governance that will maintain the Fund’s current $1 inclusive for decades, not least in the Financing for Development process. trillion resource envelope.32 In the absence of an agreement on a quota increase under the Fifteenth General Review of Quotas (further discussion 4.1 Governance reform at international institutions below), members committed to reach the $1 trillion target through a The Addis Agenda recommitted Member States to broadening and doubling of the NAB and a further temporary round of bilateral borrowing strengthening the voice and participation of developing countries in beyond 2020. The IMF membership also committed to revisit the adequacy international economic decision-making, and reiterated the commitment of quotas under the Sixteenth General Review of Quotas, which should be to further governance reform in both the IMF and the World Bank. While concluded no later than 15 December 2023. decision-making at any international institution is multifaceted, the formal The Fund has also reviewed the policy conditions to which countries agree rights to vote on policy frameworks and institutional designs matter. for IMF loans as part of its 2018-2019 review of “conditionality”. The review Figure III.F.6 shows that over the last two decades voting rights in the found that three quarters of IMF-supported programmes undertaken major institutions have remained relatively stable, although two of the 151 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

three institutions in which countries in developing regions have the lowest Bank shareholders have announced plans to discuss reforms to their voting rights have seen increases in their shares since 2015. In addition, shareholding. shareholders of the World Bank agreed in principle in April 2018 to mea- In November 2019, the FSB agreed to a set of recommendations for sures that will slowly increase the share of votes of developing countries by enhancing the effectiveness of its six Regional Consultative Groups about 0.8 percentage points in two main components of the World Bank (RCGs), through which the FSB reaches out to approximately 70 additional Group, the International Bank for Recovery and Development and the Inter- jurisdictions. The review found that both FSB and non-FSB members value 35 national Finance Corporation. the RCGs as an important mechanism to exchange views on a wide range In February 2020, the Board of Governors of the IMF adopted a resolution of financial stability issues and the implications for their regions. The concluding the Fifteenth General Review of Quotas with no increase in IMF measures will encourage greater input from non-member authorities into quotas and providing guidance on the Sixteenth Review of Quotas.36 The the work and agenda of the FSB and further strengthen the effectiveness resolution requests the Executive Board to revisit the adequacy of quotas of RCG meetings. and continue the process of IMF governance reform, including a new quota formula as a guide, and ensure the primary role of quotas in IMF resources. 4.2 Financial standard-setting bodies It also states that any adjustment in quota shares would be expected to result in increases in the quota shares of dynamic economies in line with As discussed earlier in this chapter, a number of public and private bodies their relative positions in the world economy and hence likely in the share set international standards for financial regulation and supervision of emerging market and developing countries as a whole, while protecting which countries may adopt into national frameworks. Members of these the voice and representation of the poorest members. Finally, the standard-setting bodies (SSBs) are usually national regulators. These resolution establishes that the Sixteenth Review should be concluded no institutions were generally set up by developed countries, but following later than 15 December 2023. the 2008 world financial and economic crisis, many of them gave developing countries a greater voice. In the Addis Agenda, Member States called The African Development Bank concluded negotiations on a capital for the main international SSBs to further increase the voice of developing increase in October 2019, resulting in the capital base of the bank increas- countries in norm-setting processes, although reforms since 2015 have ing by $115 billion to $208 billion. This general capital increase will not been minimal (figure III.F.7). Some SSBs have regional consultative com- change the distribution of voting rights at the bank but will allow the bank mittees or other mechanisms for taking input from developing countries to increase its lending portfolio while maintaining a high credit rating. to feed into norm-setting and/or implementation discussions, which are Neither the Inter-American Development Bank nor the Asian Development often held at an executive committee.

Figure III.F.6 Participation of countries in developing regions in the governance of international nancial institutions and regional development banks, 2000–2018 (Percentage of voting rights or seats) 70

30 2000 2005 2010 2015 2016 2017 2018 2019 IMF vote share IBRD vote share IFC vote share FSB share of plenary seats ADB vote share AfDB vote share IaDB vote share

Source: UN DESA. Note: International Monetary Fund (IMF), International Bank for Reconstruction and Development (IBRD), International Finance Corporation (IFC), Asian Development Bank (ADB), African Development Bank (AfDB), Inter-American Development Bank (IADB) show percent of voting rights. Financial Stability Board (FSB) does not have voting rights, and thus data shows number of seats at the plenary. All data categorised according to the M49 classi cation of developed and developing regions.

152 ADDRESSING SYSTEMIC ISSUES

Figure III.F.7 Countries in developing regions in the governance of standard-setting bodies, 2000–2018 (Percentage of members or executive body members) 70

0 BCBS FATF IOSCO IAIS IASB CPMI IADI IOPS

2000 2005 2010 2015 2018

Source: UN DESA. Note: The main international SSBs include the Basel Committee on Banking Supervision (BCBS) for standards on banking regulation; the Financial Action Task Force (FATF) for standards on combating money laundering, terrorist nancing and other related threats to the integrity of the international nancial system; the International Organization of Securities Commissions (IOSCO) for standards on securities regulation; the International Association of Insurance Supervisors (IAIS) for standards on insurance industry regulation and supervision; the International Accounting Standards Board (IASB) for accounting standards; the Basel Committee on Payments and Market Infrastructure (CPMI) for standards on payment, clearing, settlement systems and related arrangements; the International Association for Deposit Insurers (IADI) for deposit insurance standards; and the International Organisation of Pensions Supervisors (IOPS) for pension regulation. Basel Committee on Banking Supervision (BCBS) had no developing country members in 2000 or 2005; due to changes in governance arrangements IASB and IADI do not have data before 2005, and IOSCO and IOPS do not have data before 2010. 4.3 Improving cooperation, coordination and policy International policy coherence can also be advanced when senior leaders coherence take up an issue and raise its visibility. For example, the increased attention on central banks and regulatory authorities taking account of environmen- Almost every institution discussed above was created by a group of nations tal risks (see above) may have been driven by executive vision. The issue acting in concert to meet a need for global or regional cooperation around was first raised at the international level in 2015 when the FSB, at the re- one or more specific issues. In each case, member Governments set the quest of the G20, created the TCFD. While the TCFD has been successful, few missions and designed the operations of the entity. They have differing de- would claim that the financial sector fully integrates climate risk. To raise grees of continuing input from Member States—as well as non-Member the issue, the IMF organized a high-profile panel during its 2019 Annual States and other stakeholders—on their policies, budgets and operations. Meetings, followed by a speech by the Chairman of the Board of the Bank The governing boards of the different institutions naturally focus on their for International Settlements at a major financial conference two weeks direct responsibilities as governors of those institutions. Having these institu- later. The need for financial policy to pay attention to the lack of sufficient tions embrace policy measures that seek to enhance coherence with global progress on slowing climate change exemplifies the interrelatedness of goals beyond their own specific mandates can require a broader vision. For the financial and climate issues and the need for stronger policy measures. example, in May 2019, the IMF adopted a new strategy on engaging in social That the former Chair of the FSB will now serve as the United Nations spending issues in its member countries. The Fund’s Independent Evaluation Secretary-General’s Special Envoy on Climate Action and Finance37 is a Office had taken up the matter in the aftermath of politically charged public sign that coherence can be advanced, albeit sometimes only slowly. responses in various countries to austerity policies, coupled with academic The approach of the Seventy-fifth Anniversary of the United Nations and advocacy studies. Under the new strategy, the Fund will further promote presents an opportunity to consider the Organization’s role in positive “adequate, efficient and sustainable” social spending in its member countries, change. The Charter of the United Nations gives it formal responsibility and cooperate more intensively with other international institutions that for overall coordination of international cooperation in the economic and work on social spending, such as the International Labour Organization, the social field, mainly through preparation of global analyses and intergov- United Nations Children’s Fund (UNICEF) and the World Bank, while also ernmental negotiation of agreed recommendations. Indeed, this Task Force inviting civil society organizations to engage more with the Fund. has helped to strengthen coherence of analytical work across the system.

153 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

The United Nations General Assembly and the United Nations Economic The United Nations forum is not empowered to force coherence on the and Social Council (ECOSOC) serve as the main forums for forging a global policy choices of the global family of institutions and bodies, which are, consensus around key economic and social policy norms and targets, most ultimately, independent entities. To meet the needs of the 2030 Agenda, recently in the 2030 Agenda for Sustainable Development and its Sustain- this system needs to both set rules that allow predictability and promote able Development Goals and the Addis Ababa Action Agenda on Financing long-term thinking, while at the same time being flexible enough to for Development. The discussions—in particular in the ECOSOC Forum on respond to emerging opportunities and challenges and adjust to new Financing for Development Follow-up—of the full range of policies to realities, such as technological change. It needs to work with a measure advance financing of sustainable development illustrates how the United of humility, often outside the limelight, quietly building consensus on the Nations can contribute to coherence by bringing different institutions, Gov- essential challenges of our day. ernments and other stakeholders together through its convening authority.

Endnotes 1 FSB, “Implementation and Effects of the G20 Financial Regulatory Reforms: Fifth Annual Report” (Basel, FSB, 2019). Available at https://www.fsb. org/2019/10/implementation-and-effects-of-the-g20-financial-regulatory-reforms-fifth-annual-report/. 2 Ibid. 3 Ibid. 4 In 2018, the FSB renamed its work stream from “transform shadow banking into resilient market-based finance” to “enhancing the resilience of non-bank financial intermediation”. The change in terminology does not affect the substance or coverage of the agreed monitoring framework and policy recommendations, which aim to address bank-like financial stability risks arising from non-bank financial intermediation. 5 FSB, “Implementation and Effects of the G20 Financial Regulatory Reforms.” 6 World Bank, “Global Financial Development Report 2019/2020: Bank Regulation and Supervision a Decade after the Global Financial Crisis”, Global Finan- cial Development (Washington D.C., World Bank Group, 2020). 7 FSB, “Global Monitoring Report on Non-Bank Financial Intermediation 2019” (Basel, FSB, January 2020). Available at https://www.fsb.org/wp-content/ uploads/P190120.pdf. 8 Ibid. 9 BIS, “Investigating the Impact of Global Stablecoins: A Report by the G7 Working Group on Stablecoins,” CPMI Papers No. 187 (18 October 2019). Available at https://www.bis.org/cpmi/publ/d187.pdf. 10 Ibid. 11 Official Records of the General Assembly, Seventy-fourth Session (A/RES/74/202). Available at https://undocs.org/en/A/RES/74/202. 12 Codruta Boar, Henry Holden, and Amber Wadsworth, “Impending Arrival - a Sequel to the Survey on Central Bank Digital Currency”, BIS Papers No 107 (BIS, 23 January 2020). Available at https://www.bis.org/publ/bppdf/bispap107.htm.Henry Holden and Amber Wadsworth, January 2020. 13 Malte Krüger, Franz Seitz, and Hetzenrichter Weg, “Costs and Benefits of Cash and Cashless Payment Instruments” (Bundesbank, 15 December 2014). There is little systemic research on the costs of cash systems for developing countries. 14 Committee on Payments and Market Infrastructures, “Central Bank Digital Currencies” (BIS, March 2018). Available at https://www.bis.org/cpmi/ publ/d174.pdf. 15 In a token-based system, payment verification is conducted by examining the validity of the token, much as is done with cash currently. In an account-based system, payment verification is based on whether the person is truly the account holder, which usually relies on an intermediary. 16 Tommaso Mancini Griffoli and others, “Casting Light on Central Bank Digital Currencies,” Staff Discussion Notes (Washington D.C., IMF, 12 November 2018). Available at https://www.imf.org/en/Publications/Staff-Discussion-Notes/Issues/2018/11/13/Casting-Light-on-Central-Bank-Digital-Currencies-46233. 17 Committee on Payments and Market Infrastructures, “Central Bank Digital Currencies.” 18 Larry D Wall, “Fractional Reserve Cryptocurrency Banks,” (Federal Reserve Bank of Atlanta, April 2019). Available at https://www.frbatlanta.org:443/ cenfis/publications/notesfromthevault/04-fractional-reserve-cryptocurrency-banks-2019-04-25. 19 Patrick Bolton and others, The Green Swan: Central Banking and Financial Stability in the Age of Climate Change (BIS, 2020). Available at https://www.bis. org/publ/othp31.pdf.

154 ADDRESSING SYSTEMIC ISSUES

20 Russel Gold, "PG&E: The First Climate-Change Bankruptcy, Probably Not the Last", Wall Street Journal, 18 January 2019, https://www.wsj.com/articles/ pg-e-wildfires-and-the-first-climate-change-bankruptcy-11547820006. 21 Tobias Adrian, James Morsink, and Liliana B Schumacher, “Stress Testing at the IMF,” Departmental Paper No. 20/04 (Washington D.C., IMF, 5 February 2020). Available at https://www.imf.org/en/Publications/Departmental-Papers-Policy-Papers/Issues/2020/01/31/Stress-Testing-at-the-IMF-48825. 22 Network for Greening the Financial System, “A Call for Action: Climate Change as a Source of Financial Risk”. Available at https://www.ngfs.net/sites/ default/files/medias/documents/ngfs_first_comprehensive_report_-_17042019_0.pdf. 23 Christophe Courbage and others (eds), “Special Issue on Climate Change and Insurance”, The Geneva Papers on Risk and Insurance — Issues and Practice, vol. 34, Issue 3 (July 2009). 24 Signe Krogstrup and William Oman, “Macroeconomic and Financial Policies for Climate Change Mitigation: A Review of the Litera- ture,” Working Paper (Washington D.C., IMF, September 2019). Available at https://www.imf.org/en/Publications/WP/Issues/2019/09/04/ Macroeconomic-and-Financial-Policies-for-Climate-Change-Mitigation-A-Review-of-the-Literature-48612. 25 Michel Aglietta, Étienne Espagne, and others, “Climate and Finance Systemic Risks, More Than an Analogy? The Climate Fragility Hypothesis,” CEPII Work- ing Paper (CEPII, 2016). 26 PBC, “The People’s Bank of China and Six Other Agencies Jointly Issue‘Guidelines for Establishing the Green Financial System’”. Available at http://www. pbc.gov.cn/english/130721/3131759/index.html. 27 Tobias Adrian, “Monetary and Financial Stability During the Coronavirus Outbreak,” (Washington D.C., IMF, March 11, 2020). Available at https://blogs.imf. org/2020/03/11/monetary-and-financial-stability-during-the-coronavirus-outbreak/. 28 IMF, FSB, BIS, “Elements of effective macroprudential policies: lessons from international experience,” (31 August 2016). Available at https://www.imf. org/external/np/g20/pdf/2016/083116.pdf. 29 IMF, “IMF 2018 taxonomy of capital flow management measures”. Available at https://www.imf.org/external/np/g20/pdf/2018/092818.pdf. 30 IMF, “IMF advice on capital flows,” Draft Issues Paper for an Evaluation by the Independent Evaluation Office (19 June 2019). Available at https://ieo.imf. org/en/our-work/Evaluations. 31 IMF, “IMF Executive Board Discusses Proposals for Toolkit Reform, Concludes Review of the Flexible Credit Line and Precautionary and Liquid- ity Line”, press release No. 17/507 (Washington DC: IMF, 19 December 2017). Available at https://www.imf.org/en/News/Articles/2017/12/19/ pr17507-imf-executive-board-discusses-proposals-for-toolkit-reform. 32 IMF, “IMF Membership Endorses Package on IMF Resources and Governance Reform”, press release No. 19/379 (Washington DC: IMF, 18 October 2019). Available at https://www.imf.org/en/News/Articles/2019/10/18/pr19379-imf-membership-endorses-package-on-imf-resources-and-governance-reform 33 IMF, “2018 review of programme design and conditionality,” IMF Policy Paper (May 2019). Available at https://www.imf.org/en/Publications/ Policy-Papers/Issues/2019/05/20/2018-Review-of-Program-Design-and-Conditionality-46910. 34 IMF, “2018–19 review of facilities for low-income countries—reform proposals; review of the financing of the Fund’s concessional assistance and debt relief to low-income member countries,” IMF Policy Paper (June 2019). Available at https://www.imf.org/en/Publications/Policy-Papers/Issues/2019/06/0 6/2018-19-Review-of-Facilities-for-Low-Income-Countries-Reform-Proposals-Supplementary-46970. 35 The increase will take place slowly as countries pay in the shares over many years that had been agreed in the general and selective capital increases of 2018, see “World Bank Group Shareholders Endorse Transformative Capital Package” (Washington D.C., April 2018). Available at https://www.worldbank. org/en/news/press-release/2018/04/21/world-bank-group-shareholders-endorse-transformative-capital-package. Board of Governors, “Resolu- tion No. 664: 2018 Selective Capital Increase” (Washington D.C., World Bank, October 2018). Available at http://documents.worldbank.org/curated/ en/370231538549507417/pdf/130436-BR-PUBLIC-resolution-ADD-SERIES-IBRD664-2018SelectiveCapitalIncrease.pdf. 36 IMF, “IMF Board of Governors Approves a Resolution on Quota Reviews”, press release 20/50 (13 February 2020). Available at https://www.imf.org/en/ News/Articles/2020/02/13/pr2050-imf-board-of-governors-approves-a-resolution-on-quota-reviews. 37 United Nations, “Secretary-General Appoints Mark Joseph Carney of Canada Special Envoy on Climate Action and Finance”, press release, 1 December 2019.

155 Infographic Goes Here SCIENCE, TECHNOLOGY, INNOVATION AND AND INNOVATION TECHNOLOGY, SCIENCE, CAPACITY-BUILDING Chapter III.G Science, technology, innovation and capacity-building 1. Key messages and recommendations

To achieve the Sustainable Development Goals (SDGs), countries Both the Technology Facilitation Mechanism (TFM) and the at all stages of development must increase their capacities in Technology Bank—two key outcomes of the Addis Agenda in science, technology and innovation (STI). New practices and support of STI—have been set up and operationalized over the technologies need to be developed and transferred where they past few years. Continued joint efforts of Member States of are most needed in order to strengthen productivity growth, the United Nations, supported by the United Nations system, lower the environmental impact, and reduce inequalities can help these mechanisms deliver on their mandates, to sup- between and within countries. Governments, companies and port developing countries’ adaptation of new technologies for civil society organizations need to ensure that technological sustainable development. discoveries are transformed into innovations that respond to The next section reviews a comprehensive set of STI indicators, society’s needs and contribute to sustainable development. highlighting progress and areas for further action. Section 3 This chapter complements the analysis of the thematic analyses main trends in new and emerging technologies and chapter (chapter II)—which addresses the role of digital their impact on sustainable development, while section 4 re- technologies—by reviewing the progress in implementing the views their effect on the financial sector and financial inclusion. commitments and calls for action on and capacity-building in Section 5 takes stock of United Nations actions on STI, including the Addis Ababa Action Agenda. support for the TFM and the Technology Bank. While there has been important progress in most STI indicators, large gaps remain between developed and developing countries, particularly in least developed countries (LDCs); for instance, the 2. Measuring progress towards gap in research and development (R&D) spending between developed and developing countries has increased in most regions. the Addis Agenda in science, While the gender gap has shrunk in most countries with respect to tertiary education, it remains large in terms of Internet access technology and innovation and has increased in LDCs overall. Knowledge-sharing and col- While the Addis Agenda does not provide quantitative targets, laboration should be strengthened to ensure that no one is left this section reviews indicators that can help assess progress behind, including by supporting education systems, improving in the area of STI. It highlights areas of progress and those affordable access to the Internet and further increasing inter- where additional policy action is needed. It also reveals a lack national cooperation in science, technology and innovation. of comparable information across countries for many relevant commitments. New and emerging technologies have spread rapidly, supporting SDG progress and spurring financial innovation and The commitments are clustered around three areas: (i) provid- inclusion in particular. Over time, the impact of these technolo- ing an enabling environment, by improving connectivity and gies will affect all sectors and countries. All countries need to promoting entrepreneurship; (ii) increasing learning and develop and strengthen their capacities for technological innovation by public and private actors, including by raising adaptation and innovation, in line with the development enrolment in tertiary education, employing more researchers of national innovation systems and regulatory frameworks, and investing more in R&D; and (iii) transferring knowledge supported by an enabling international environment. across borders, by increasing foreign direct investment (FDI) 157 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

in R&D activities, encouraging the movement of students, strengthening per cent; as an extreme example, in the Democratic Republic of the Congo, online learning and increasing international cooperation. at 20 dollars per month, the cost reaches 53 per cent of GNI per capita. Poor and marginalized groups continue to face barriers to Internet access, and all 2.1 Providing an enabling environment the opportunities that come with it. Women are still 16 per cent less likely than men to access the Internet in developing countries (33 per cent less in People are more connected LDCs), and the gender gap is widening in the Asia-Pacific region, Africa and Western Asia as men are gaining access at a faster rate than women.2 To raise capabilities in STI, people need to be connected. Globally, the number of broadband subscriptions is on the rise, although with a different Entrepreneurship is rising pattern between developed and developing countries. While in developed countries, there are now 36 fixed broadband connections for every 100 New ideas need to be put into action, and while large companies have persons, developing countries only reach 11 connections per 100 inhabitants, more capacity for R&D, it is often newer, more agile firms that can imple- and LDCs only 2. On the other hand, mobile broadband connections are rising ment the most innovative ideas. Markets with many new companies faster in developing countries, reaching 75 connections per 100 inhabitants.1 also tend to be more competitive, which can spur innovations from all companies, both new and old. Available data shows that new business reg- As a result, the number of people using the Internet continues to grow, istrations of private, formal sector companies grew over the past decade reaching 54 per cent of the global population in 2019. The gap between across the world (figure III.G.2). On average there are more new business developed and developing countries has narrowed considerably, especially registrations in developed economies, but with large variations among for Latin America and the Caribbean, Western Asia, and East and Southeast countries, reflecting institutional differences. All 29 African and Asian coun- Asia (figure III.G.1). Still, almost half the world is not connected. Internet tries with available data registered an increase over the previous decade. use in Africa and South Asia is still much lower but has been growing at a faster pace. Growth was slowest in LDCs, causing them to fall further behind in terms of connectivity. 2.2 Increasing learning and innovation by public and private actors Affordability of services is a major barrier for expanding usage; almost a third of the world’s people live in countries where broadband plans are unafford- able for average incomes. While in almost all developed countries, a mobile More people are getting tertiary education broadband subscription with a 1.5 Gb data package costs less than 2 per cent In the Addis Agenda, Member States pledged to enhance vocational and of gross national income (GNI) per capita, in most LDCs it costs more than 5 tertiary education and to scale up investments in science, technology,

Figure III.G.1 Percentage of individuals using the Internet, 2006 and 2017 (Percentage)

0 Africa East and South South Asia Western Asia Developed Latin America LDCs East Asia countries and the Caribbean

2006 2017

Source: UNCTAD, based on ITU. 158 SCIENCE, TECHNOLOGY, INNOVATION AND CAPACITY-BUILDING

Figure III.G.2 New business registrations per 1,000 people, 2006 and 2017

4.5

4.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5

0 Africa Latin America East and South Asia Western Asia LDCs Developed and the South East countries Caribbean Asia

2006 2017

Source: UNCTAD, based on World Bank. engineering and mathematics education.3 While enrolment rates in tertia- are 3,915 researchers per million inhabitants in 2017, there are only 280 in ry education are growing across the world, disparities between countries South Asia and 103 in Africa. persist, and enrolment rates in LDCs (while doubling since 2006) are only a fraction of those in developing countries overall. Regionally, enrolment 2.3 Transferring knowledge across borders rates have doubled in Asia and grown by a third in Latin America and the Caribbean since 2006 (figure III.G.3.A).4 Despite some positive developments discussed above, large disparities between countries persist. Strengthening tertiary education systems, Women have higher enrolment rates in tertiary education than men overall, increasing access to online education in areas related to sustainable but with large disparities between regions. Women have higher enrolment development, and stepping up international cooperation in STI can help rates in developed countries and in Latin America and the Caribbean, but developing countries harness STI for the sustainable development agenda. in Africa and South Asia they only recently reached parity (figure III.G.3.B). Enrolment rates in LDCs are one third lower for women than men, but the More people are moving abroad to study gap has narrowed over the past decade. Giving students the opportunity to pursue their tertiary education abroad More resources are devoted to R&D widens the possibilities for individuals and helps upgrade scientific capabilities for home countries, especially for small and developing countries. In The Addis Agenda calls for more resources devoted to STI. Indeed, invest- the short to medium term, study abroad can be an opportunity to complement in research and development increased from 1.55 to 1.68 per cent ment the capacities of national education systems, although it needs to be of world gross domestic product (GDP) from 2006 to 2016. Outside East well-managed to avoid increasing brain drain. and Southeast Asia, however, the gap between developed and developing economies was not reduced (figure III.G.4). In South Asia, R&D spending The share of tertiary students studying abroad grew significantly over the as a share of GDP declined. The share of total R&D investment that comes last decade. The share is highest in developed countries, but it also increased from Governments (as a percentage of GDP), which historically has been an in most developing regions—except in Africa, where an exceptionally high important driver of innovation, dropped slightly over the past ten years.5 rate of students studied abroad in 2006 and domestic university enrolment significantly expanded in the following decade (figure III.G.5). The number of researchers worldwide is growing, and developing countries as a group have been catching up, albeit from a low base. In all regions, Official development assistance (ODA) for education grew by 10 per cent in except in Central Asia, the R&D gap between developing and developed real terms between 2006 to 2017 and, within that, ODA to tertiary educa- countries has narrowed, although progress in Africa and the LDCs has been tion grew by 7 per cent. Nonetheless, this lagged the overall growth of ODA 6 modest and differences are still large. While in developed countries there of 21 per cent. 159 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Figure III.G.3.A A. Gross enrollment rates in tertiary education, 2006 and 2017 (Percentage)

0 Africa Latin America East and South Asia Western Asia LDCs Developed and the South East countries Caribbean Asia

2006 2017

Source: UNCTAD, based on UNESCO.

Figure III.G.3.B B. Gender gap in gross enrollment rate, by region, 2006 and 2017 (Percentage)

0.40

0.30

0.20

0.10

0.00

–0.10

–0.20

–0.30

–0.40

–0.50

–0.60 Africa Latin America East and South Asia Western Asia LDCs Developed and the South East countries Caribbean Asia

2006 2017

Source: UNCTAD, based on UNESCO. 160 SCIENCE, TECHNOLOGY, INNOVATION AND CAPACITY-BUILDING

Figure III.G.4 Research and development spending as a percentage of GDP, 2006 and 2017 (Percentage)

3.0

2.5

2.0

1.5

1.0

0.5

0 Africa Latin America East and South Asia Western Asia Developed LDCs and the South East countries Caribbean Asia

2006 2017

So urce: UNCTAD, based on UNESCO.

Figure III.G.5 Percentage of tertiary students abroad, by region of origin, 2006 and 2017 (Percentage)

0 Africa Latin America East and South Asia Western Asia LDCs Developed and the South East countries Caribbean Asia

2006 2017

Source: UNCTAD, based on UNESCO. 161 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

More people enrol in online education FDI can also contribute to STI capacities in a more direct way, when multinational corporations locate R&D facilities in developing countries— Online education is another opportunity to upgrade skills beyond the which they do partly to access the growing set of skilled workers and partly possibilities offered by national education systems. The number of massive to access policy advantages targeting this type of investment. However, online open courses (MOOCs), one of the most popular methods of online companies locate R&D facilities only in places with strong innovation ca- education, has increased dramatically in the past few years. Nonetheless, pacities, which only a handful of developing countries have. Data from FDI there are important barriers for enrolment in developing countries related Markets8 shows that multinational corporations concentrate most of their to connectivity, skills (most MOOC participants already have some univer- R&D projects in developed countries,9 and that this proportion has been sity education) and language (most courses are offered in English and a few stable over the past decade. Moreover, projects that do go into developing other international languages). There is no official data on the use of online countries are highly concentrated in China (17 per cent of the total between education, but enrolment figures from Coursera, the world’s leading online 2006 and 2018) and a few other countries in East Asia (11 per cent) and learning platform for higher education, show that, while enrolments are Latin America and the Caribbean (4 per cent). Africa receives only 1 per cent more common in developed countries, developing countries are catching of the total, and there has been no single project registered in an LDC. up fast (figure III.G.6). The high level of adoption of Coursera in Latin America reflects in part the availability of courses in Spanish (registrations from Brazil are well below the regional average) and partnerships with 2.4 International collaboration local universities that tailor the content to local needs. Beyond education (reviewed above), ODA also directly targets STI activities. While there is no internationally agreed measure of ODA for STI,10 Foreign direct investment flows to developing countries are not estimates show a sharp increase in such funds since 2014 (figure III.G.7). growing ODA for STI has outpaced total ODA growth since 2014, indicating increased donor commitment to this area. ODA for STI to LDCs also increased in recent The Addis Agenda also calls for the international community to “foster link- years, doubling between 2016 and 2018, albeit from low levels. ages between multinational companies and the domestic private sector to facilitate technology development and transfer”.7 While overall flows of Medical research is one of the areas receiving increased ODA in the past FDI to developing countries have been relatively constant in nominal terms, few years. There are several important initiatives that are also supported the stock of FDI in these countries has grown. This increase in multinational by private companies and donors, such as the Vaccine Alliance, The Pool corporations’ productive capacities in developing countries implies greater for Open Innovation Against Neglected Tropical Diseases or the Drugs for opportunities for technology transfer to domestic companies. Neglected Disease Initiative.11

Figure III.G.6 Number of registered students in Coursera per 100,000 inhabitants, by region, 2012 and 2018

3.0

2.5

2.0

1.5

1.0

0.5

0 Developed Africa Asia East Europe and Latin America Central Asia 2012 2018

Source: UNCTAD, based on data provided by Coursera.

162 SCIENCE, TECHNOLOGY, INNOVATION AND CAPACITY-BUILDING

Figure III.G.7 ODA ows to developing countries targeting science, technology and innovation activities, 2000–2018 (Billions of United States dollars)

3.0

2.5

2.0

1.5

1.0

0.5

0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Developing countries Least developed countries Landlocked developing countries Small island developing States

Source: UN DESA, based on OECD/DAC.

The Addis Agenda also encourages the dissemination of environmentally chapter II, others going beyond the digital field (table III.G.1). It then sound technologies to developing countries. Several institutions have been explores the potential impact of these technologies on the SDGs. created for this purpose, such as the Green Climate Fund, Eco-Patent Com- mons or WIPO-Green Marketplace for Sustainable Technology. A survey of Table III.G.1 participants in this market revealed that intellectual property rights are Emerging technologies not a major barrier for the adoption of environmentally sound technolo- Artificial intelligence The capability of a machine in cognitive activities typically gies, and that scientific infrastructure, human capital or the investment performed by human brains, such as perceiving, reasoning, learning, interacting with the environment, problem solving, climate are far more relevant.12 and even exercising creativitya Within the United Nations Framework Convention on Climate Change Internet of things Large number of physical devices that are collecting and sharing b (UNFCCC), the Clean Development Mechanism was designed to allow tech- data through the Internet nology transfer to developing countries, but relatively few projects have Big data Datasets whose size or type is beyond the ability of traditional achieved this aim so far. Currently, the UNFCCC Technology Mechanism— databases to capture, manage and process hosted by the United Nations Environment Programme and the United Distributed ledger tech- A time-stamped series of immutable records of data, supported nology / blockchain by a resilient distributed architecture, which can be public (e.g., Nations Industrial Development Organization—promotes this type of Bitcoin, Ethernet) or private (e.g., private stablecoins or supply technology transfer. Since 2014, it has received 284 requests for technical chain ledgers) assistance and started 180 technology transfer projects, from supporting 5G The next generation of mobile Internet connectivity, with e-mobility transition in Jakarta to assessing geothermal resources in Kenya. download speeds of around 1-10 Gbps (4G is around 100 Mbps)c and more reliable connectionsd 3D printing Production of three-dimensional objects using a digital file Robotics Programmable machines able to carry out actions and interact 3. New and emerging technologies and with the environment via sensors and actuators either autono- mously, or semi-autonomouslye the Sustainable Development Goals Drones Flying robots that can be remotely controlled or fly autono- Chapter II analysed the impact of digital technologies on financing policies mously with the help of on-board sensors and GPS and institutions. This section reviews trends in nine relevant new and Gene editing A tool to insert, delete or modify genomes in organisms (also f emerging technologies—some in the digital domain and discussed in known as genome editing)

163 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Source: UNCTAD (forthcoming), Technology and Innovation Report 2020. Table III.G.2 a McKinsey&Company, “An executive’s guide to AI.” Available at https://www. Top technology providers (AI, IoT, big data, blockchain, 5G, 3D printing, robotics, mckinsey.com/business-functions/mckinsey-analytics/our-insights/an- drone and gene editing) executives-guide-to-ai. AI IoT Big data Blockchain 5G b Steve Ranger, “What is the IoT? Everything you need to know about the Internet of Things right now.” Available at https://www.zdnet.com/article/ Alphabet Alphabet Alphabet Alibaba Ericsson what-is-the-Internet-of-things-everything-you-need-to-know-about-the-iot- Amazon Amazon Amazon Web Amazon Web Huawei (network) right-now/. Services Services c Sacha Kavanagh, “How fast is 5G?” Available at https://5g.co.uk/guides/how- Apple Cisco Dell Technologies IBM Nokia fast-is-5g/. d John McCann, Mike Moore and David Lumb, “5G: everything you need to IBM IBM HP Enterprise Microsoft ZTE know.” Available at https://www.techradar.com/news/what-is-5g-everything- Microsoft Microsoft IBM Oracle Huawei (chip) you-need-to-know. e Alex Owen-Hill, “What's the Difference Between Robotics and Artificial Oracle Microsoft SAP Intel Intelligence?” Available at https://blog.robotiq.com/whats-the-difference- PTC Oracle MediaTek between-robotics-and-artificial-intelligence. Salesforce SAP Qualcomm f Reports and Data, “Genome Editing Market To Reach $10.1 Billion By 2026 | CAGR: 14.8%” Available at https://www.reportsanddata.com/press-release/ SAP Splunk Samsung Electronics global-genome-editing-market. Teradata 3D printing Robotics Drone Gene edition 3.1 Technology trends and key players 3D Systems ABB 3D robotics CRISPR Therapeutics Artificial intelligence (AI) is the technology that has received the most ExOne Company FANUC DJI Innovations Editas Medicine attention from researchers, as measured by the number of publications, HP KUKA Parrot Horizon Discovery Group which totalled over 400,000 between 1996 and 2018. Robotics followed, Stratasys Mitsubishi Electric Yuneec Intellia Therapeutics with over 250,000 publications in the same period. AI also accounts for the largest number of patents filed during those years, followed by the Yaskawa Boeing Precision BioSciences Internet of things (IoT).13 Hanson Robotics Lockheed Martin Sangamo Therapeutics China and the United States of America are the most active countries in re- PalRobotics Northrop Grumman search across the 9 technologies, respectively accounting for 16 and 24 per Robotis cent of publications and 46 and 16 per cent of patents.14 Their companies Softbank Robotics are also industry leaders in most of these areas, implying a transition from Alphabet/Waymo the traditional developed-developing country divide. Companies from the Aptiv United States dominate the fields of AI, Internet of things, big data and GM distributed ledger technology (DLT). These areas benefit extensively from the services of cloud computing platforms, the most important of which Tesla are based in the United States. Chinese companies play a relatively more Source: UNCTAD (forthcoming), Technology and Innovation Report 2020. active role in manufacturing-related technologies such as 5G, robotics and Note: Top technology providers are determined on the basis of reports from market research companies. American companies are marked in green, Chinese drones (table III.G.2). companies in orange and others in grey. Only 5G and robotics are not dominated by American or Chinese companies. In these two technologies, traditional manufacturing companies take the most widespread, with an estimated annual market size of $69 billion. lead, such as Samsung from the Republic of Korea, Mitsubishi from Japan, Other technologies with the potential for wide applications, such as gene or ABB, Ericsson and Nokia from Europe. editing or DLT, have a relatively small market size, as mass applications Regarding implementation, the IoT is currently the most widespread have not yet been developed. The expansion of 5G seems assured, but it technology provider, with an estimated annual market size of $130 billion still has a relatively small footprint as of 2018 (table III.G.3). worldwide. It involves a wide range of components already in use, such While some of these technologies have already reached appreciable as smartphones, wearables and computers, and has important industrial market size, their real importance lies in their potential to grow and applications, such as smart meters and thermostats. Drones are the second disrupt larger industries. It is not the current size of the robotics industry

Table III.G.3 Market size estimates of new technologies (Billions of United States dollars) Technology AI IoT Big data Blockchain 5G 3D printing Robotics Drones Gene editing Year of estimate 2017 2018 2017 2017 2018 2018 2018 2017 2018 Market size 16 130 32 1 1 10 32 69 4 Source: UNCTAD (forthcoming), Technology and Innovation Report 2020.

164 SCIENCE, TECHNOLOGY, INNOVATION AND CAPACITY-BUILDING that is relevant, but the capacity of robots to radically transform a large countries to bypass intermediate stages of technology without neglecting industry—such as the automotive industry, with a market size of over $1 traditional and more labour-intensive development pathways (see chapter trillion. Crucially, they are all, to different degrees, multipurpose technolo- II for a discussion of such a two-pronged approach). To reap the full bene- gies that can be applied to practically all sectors in the short to medium fits, developing countries need to increase the capacity of their institutions term. This highlights the importance, for all countries, of continuing to to adapt and absorb foreign technologies and to generate local innovations invest in these areas. (box III.G.1). In addition to local capacities in developing countries, there is Still, not all industries will be equally affected, nor will all industries adopt also a need for a global enabling environment for creating, diffusing and new technologies at the same pace. For example, the manufacturing adapting knowledge that is relevant for the SDGs. sector is a top user of almost all new technologies, including for predictive maintenance, quality control, human-robot collaboration, design, and adoption to market demands. The financial sector is a big user of AI, the IoT, 4. Fintech trends and financial big data and DLT for credit decisions, risk management, fraud prevention, trading, personalized banking and process automation (see chapter II). inclusion New and emerging technologies have already begun to transform the 3.2 Impact on the sustainable development agenda financial sector (see chapter II), and fintech has been an important driver of financial inclusion. Developments in financial technology have Deploying new technologies could be transformative for the sustainable been shaped by country-specific conditions, including differences in the development agenda, as they offer solutions that are better, cheaper, availability and quality of necessary infrastructure and complementary more scalable and faster to replicate. They can raise productivity, increase technology, as well as financial sector characteristics and regulatory environmental sustainability (see box II.3 in chapter II) and improve the standards. As a result, fintech growth has been uneven among countries delivery of basic services. For example, during the COVID-19 crisis, open and regions. government data has helped some countries rapidly map the outbreak, thus helping contain transmission. Nonetheless, without strong regulatory The benefits of fintech do not materialize automatically, and country and policy frameworks, they can also lead to rising inequality within and authorities need to provide the appropriate enabling environment while between countries (see chapter II), although new technologies (driven by mitigating associated risks, including excessive borrowing, fraud, loss the technological and market leadership of China and the United States) no of financial integrity (i.e., use of fintech tools for money laundering and longer display a traditional developed-developing country divide. terrorism financing purposes), new forms of exclusion and data privacy concerns. Policymakers can help guide new technological solutions towards the most pressing problems, as defined by the sustainable development agenda, While global fintech activities have grown rapidly in recent years, their and also use regulatory and policy frameworks to prevent the rise in exact scope is difficult to assess, given the fast-paced innovation cycle and inequality within countries that may come with technological change. lack of internationally agreed definitions. Only limited data is available, mainly from research organizations and consultancies, focusing on select Even if national innovation systems are weaker in developing countries, indicators and data sources. Nevertheless, it is possible to identify some new technologies can create opportunities for leapfrogging, allowing key trends, at both the global and regional levels.

Box III.G.1 A new concept for scientific and innovative development in Kyrgyzstan Based on its National Strategy for Sustainable Development 2013-2017, the Government of Kyrgyzstan in 2017 introduced the “Concept for scientific and innovative development until 2022” (Concept 2022). Its goal is to strengthen the country’s national innovation system (NIS) to address several challenges, such as the fragmented governance structure of existing innovation networks and insufficient linkages between research institutes and the private sector. While education levels are relatively high compared to countries with similar income levels, research institutes have been poorly funded and staffed. A relatively small and inward-looking private sector has meant limited demand for research and development services. Innovation governance across a nascent network of innovation intermediaries—incubators, technoparks and technology transfer centres—has been fragmented across multiple institutions and insufficiently resourced. To overcome these obstacles, Concept 2022 takes a holistic approach to developing applied research capacity in priority areas such as food security, information and communications technology, health, energy, and tourism. Following an integrated NIS concept, it addresses most aspects of the system, rather than focusing only on research, as previous approaches did. It prioritizes the absorption and adaptation of existing technologies as a more realistic goal rather than aiming to develop competitive expertise at the global technology frontier. It puts the Kyrgyz manufacturing industry at the centre of efforts, aiming to get other parts of the innovation system—including over 70 applied research institutes—to support its modernization. It also emphasises international cooperation, foreign direct investment linkages, and technology transfer centres. Source: ECE (2019), Innovation for Sustainable Development Review of Kyrgyzstan.

165 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

4.1 The evolving fintech landscape Big tech in finance Big tech companies are increasingly entering the market for financial Investment in fintech companies services, using the comparative advantages provided by their large number of established users, wealth of data, and analytical capacity. Financial Annual investment trends in fintech companies show a slowdown services can also create synergies with existing big tech activities and after several years of strong growth, amid some signs that the sector strengthen the dynamic feedback loop between data analysis, network is beginning to mature. Total investment in fintech through venture externalities and other activities.18 For example, payment services are capital (VC), private equity (PE) and mergers and acquisitions (M&A) a natural extension for e-commerce platforms that facilitate a smooth rose from $18.9 billion in 2013 to $135.7 billion in 2019. The average customer experience and guarantee the settlement of transactions in a deal size more than tripled, from $16.7 million to $50.4 million over this fully integrated system, while providing the platforms with additional time, suggesting that firms getting funded or acquired have become information about users’ payment behaviour. more mature over the years.15 Fintech investments continue to be highest in the Americas, although growth rates there have moderated, All major big tech companies are now offering integrated payment systems, while investment in European fintech has increased steadily since 2016 accounting for about 11 per cent of their revenues in 2018.19 Some use (figure III.G.8). The slight decline in total investments in 2019 followed third-party infrastructures to process and settle payments while others a spike in 2018 that was driven by a few megadeals, including a record have developed their own proprietary systems. Like other fintech services, late-stage VC financing round for Ant Financial and a very large private big tech’s proprietary payment systems have expanded more in places equity investment in Refinitiv in the second and fourth quarters, and areas less served by the traditional financial sector (such as Alibaba’s respectively.16 Ant Financial and Tencent’s WeChat Pay). This, in addition to the large size of their user base, could explain the important role big tech companies In 2018 and 2019, M&A was a main driver of fintech investment in the play in the Chinese mobile payment sector (figure III.G.9). Increasingly, Americas and in Europe, in an early sign of consolidation in more mature some big tech companies are also offering other types of services, such fintech categories, such as payments, as well as an increase in the purchase as cross-border payments (including remittances), money market funds, of fintech start-ups by incumbents. In the Asia-Pacific region, VC was the credit provision and insurance products.20 dominant source of investment in 2018, but M&A has become more important in 2019.17 Owing to their large-scale and growth potential, big tech participation in fintech presents challenges that go beyond the risks associated with

Figure III.G.8 Total ntech investment activity, by region, 2013–2019 (Billions of United States dollars)

160

141.0 135.7 140

120

100

73.7 80 64.9

60 51.2 54.4 40

18.9 20

0 2013 2014 2015 2016 2017 2018 2019 Americas (including US) Europe (including UK) Asia Paci c (including China) Total

Source: KPMG, The pulse of ntech 2019. Note: Regional reporting by KPMG is limited to three regions: Americas, Europe and Asia Paci c.

166 SCIENCE, TECHNOLOGY, INNOVATION AND CAPACITY-BUILDING

Figure III.G.9 Big tech mobile payment services, 2017 (Payment volumes as percentage of GDP)

United States1 0.60

India 0.56

Brazil2 0.35

Indonesia 0.09

United Kingdom 0.05

China3 16.53

0 2 4 6 8 10 12 14 16 18 20

Source: BIS, Annual Economic Report 2019, p.58. Note: 1 2016 data. 2 Estimate based on the public data for Mercado Libre. 3 Only mobile payments for consumption data (i.e. excluding mobile payments for money transfer, credit card payments and mobile nance). smaller-scale fintech providers, including the risk of market dominance Digital payments and questions about the extent of personal data collection and use (see Being able to access and use digital payment services through mobile chapter II). devices (mobile money) has benefited unbanked and underbanked populations—including through lower fees, time savings and reductions in travel 4.2 Fintech and financial inclusion costs—as traditional banking services are expensive, and often unavail- Fintech has supported strong growth in financial inclusion in recent able in remote locations. It is also a useful tool for MSMEs, as it permits years, across all three functional areas of financial markets (see chapter fast and frictionless settlement of accounts, and the easy access to agent III.B). In the payments arena, mobile money providers have played a networks facilitates transfers between cash and digital money. key role in enabling a growing number of users to make and receive Over the past ten years, mobile money has become an integral part of the digital payments. Regarding intermediation, alternative finance plat- payments system in a growing number of countries. As of December 2018, forms have permitted many previously underserved individuals and 866 million mobile money accounts were registered globally, and transac- enterprises to make greater use of formal financial intermediation ser- tion values reached $40.8 billion.21 This translates to average monthly vices, such as loans and savings. More recently, mobile money providers transactions worth $206 per active mobile money consumer.22 A total of have also begun to offer such services. As to information management, 46 per cent of registered mobile money customers worldwide were located microinsurance schemes have also benefited from fintech innovations, in sub-Saharan Africa, 33 per cent in South Asia and 11 per cent in East Asia both in terms of increased accessibility and improved risk assessments. and the Pacific.23 Both individuals and micro, small and medium-sized enterprises While most mobile money transactions in 2018 were still cash-in and (MSMEs) have benefitted from this increased access to and better qual- cash-out operations, the values of digital transactions have been growing ity of formal financial services, although the types of fintech services quickly, at 24 per cent year on year. The main drivers of this digital growth used by both groups are often different. For instance, in the payments were bill payments and bulk disbursements, 68 per cent of which were category, MSMEs tend to use online payment processors and mobile originated by businesses.24 Anecdotal evidence in two sub-Saharan points of sale payment machines, while consumers use other services, African countries shows that 80 per cent of MSMEs have a mobile money such as mobile money, to make purchases. However, usage also differs account, 83 per cent of which use it for business purposes.25 by country and by type of enterprise, and important overlaps exist, Digital payment of government transfers can also play an important role with microenterprises in particular often using the same services as in increasing access to the formal financial sector. While enhancing the households. efficiency of government service provision and reducing leakages, such

167 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

transfers come with the added benefit of providing a personal account to credit providers, and an additional 41 per cent were planning to launch some of the poorest and most vulnerable populations (see chapter II). such a service in 2019.31 Such blurring of lines between payment function Increased account ownership is not enough for meaningful financial and intermediation can create new risks, including overindebtedness and inclusion, if these accounts are not actively used. While in some developing fraud. This underscores the need to include those operators in the regula- countries—particularly those with widespread adoption of mobile money tory framework, based on underlying risks (see chapter II). accounts, such as Kenya—account owners make significant use of digital Overindebtedness of poor and vulnerable households has become a payments, other countries still lag behind. In India, despite increased ac- problem in several countries, including in East Africa, where mobile money count ownership, less than half of all account owners used them to make or providers have been rapidly expanding into digital lending. In addition receive at least one payment in a 12-month period in 2017.26 This points to the negative welfare impact at the household level, this may also to the need for a supportive infrastructure and payments ecosystem, in ad- imply systemic risks—depending on whether and where credit bubbles dition to financial and digital literacy and appropriate customer protection, materialize—that requires a response from regulators and supervisors. that allow people to use their accounts in safe, convenient and affordable For instance, new legislation was proposed in Kenya in 2018 for the licens- ways (see chapter II). ing and regulation of digital lenders; since May 2019, the Kenya Banking Charter requires all lenders to disclose terms and conditions.32 Digital financial intermediation Poorly run or outright fraudulent P2P lending platforms have also caused Digital lending—by digital payment firms, digital banks, through peer-to- concern, both for potential borrowers as well as for small retail funders. peer (P2P) platforms, mobile network operators in partnership with banks, In China, a dearth of consumer and MSME lending from the traditional or other models—has grown substantially over the past five years. Both banking sector and a lack of investment alternatives for savers fuelled fast individuals and MSMEs benefit from the improved access to and lower cost P2P lending growth between 2011 and 2015, with the number of platforms of credit. However, use of these technologies also creates new risks (see rising from 50 to almost 3,500. In 2016, the Chinese Banking Regulatory chapter II). Commission found that about 40 per cent of existing platforms were fraudulent, and authorities began to tighten regulations. In March 2019, Global volumes of alternative finance that consist mainly of P2P lending only 1,021 platforms remained in business, and stricter licence require- and online crowdfunding are estimated to have increased from around ments introduced in 2019 have reduced this number further.33 $12 billion in 2013 to over $415 billion in 2017.27 This expansion was driven largely by the Asia-Pacific region, which experienced the highest Digital savings, enabled through mobile money accounts or savings ac- average growth and accounted for $362 billion in 2017. Volumes in the counts linked to mobile money, can be enhanced through tools that nudge Americas and in Europe reached $44 billion and $12 billion, respectively, in users into saving on a regular basis. Key constraints in this context are a 2017. China accounted for more than 99 per cent of the alternative finance lack of understanding and trust on the side of potential clients, as well volume in the Asia-Pacific region, while the United States accounted as actual risks, since such savings are not covered by traditional deposit for around 96 per cent in the Americas and the United Kingdom of Great insurance. Where savings are channelled into P2P lending, higher expected Britain and Northern Ireland for approximately 70 per cent in Europe.28 returns also go hand-in-hand with higher risks (see chapter II). Alternative finance volumes in Africa and the Middle East remain low in terms of international comparison, at a combined $358.9 million in 2016 Digital microinsurance (by definition, this amount does not reflect the increasingly important role Mobile services can also contribute to the growth of microinsurance 29 of mobile money in several African countries). schemes, which can help vulnerable populations protect themselves Despite continued high growth, recent trends reveal a deceleration that from unexpected emergencies and shocks for very low premiums. As of most likely reflects maturity of the sector, as growth rates are measured June 2017, at least 61 million policies had been issued by mobile-enabled from an ever-increasing base. In the Asia-Pacific region, annual growth microinsurance providers across 27 countries, up from 31 million in 2015. slowed from 325 per cent in 2015 to 138 per cent in 2016 and 48 per cent in Of these policies, 39 per cent were for life insurance, 26 per cent were for 2017, while in the Americas it slowed from 145 per cent in 2015 to 23 and health insurance, and 18 per cent for bundles comprising different combi- 26 per cent in 2016 and 2017, respectively. Growth in Europe was relatively nations of life, health and accident insurance.34 By drawing on alternative lower and less volatile over time, slowing from 60 per cent in 2015 to 41 sources of data and new data processing technologies, risks can be more per cent in 2016 and 39 per cent in 2017. precisely estimated. While this allows for lower insurance premiums and A large share of alternative finance is being used for MSME funding, albeit wider coverage, there is also a risk of excluding certain individuals or 35 with regional differences. In 2017, business funding accounted for 31 groups (see chapter II). per cent of alternative finance in China, 61 per cent in other Asia-Pacific countries, 62 per cent in Europe, and over 85 per cent in Latin America and Fintech services for micro, small- and medium-sized enterprises the Caribbean. In the United States, alternative finance is mainly geared A recent survey on fintech adoption by MSMEs found that, on average, 25 towards consumption, with only 24 per cent dedicated to MSME financ- percent of digitally active MSMEs in five large economies had adopted 30 ing in 2017. fintech solutions.36 MSMEs in China had the largest adoption rate, with 61 Mobile money providers have also been extending their range of services per cent, followed by the United States (23 per cent), the United Kingdom to include credit, savings and insurance. In 2018, 23 per cent of providers (18 per cent), South Africa (16 per cent) and Mexico (11 per cent). As rea- were offering credit services through partnerships with banks or other sons for using fintech services, most MSMEs cited the range of functionality 168 SCIENCE, TECHNOLOGY, INNOVATION AND CAPACITY-BUILDING and features, the availability of services around the clock, and the ease in setting up, configuring and using the service.37 established as a tool for financial inclusion in the urban areas, as in Fiji, a focus should be placed in promoting inclusivity for those who While some fintech applications, including those discussed above, are live in rural and more isolated regions. well established and widely used, other technologies, such as DLT (or blockchain), may hold important potential for the financial inclusion of a Adapted from Hongjoo Hahm, Tientip Subhanij and Rui Almeida, “Finteching remittances in paradise: a path to sustainable development”, MSMEs, but are still largely in a pilot stage. Several studies have identified Working Paper Series, Macroeconomic Policy and Financing for Development the potential benefits of DLT for supply chain financing and trade financing Division (Bangkok: United Nations Economic and Social Commission for Asia in particular (see also chapter III.D).38 and the Pacific, October 2019).

Enabling factors Despite the progress noted above, technological innovations per se do 5. United Nations actions on science, not necessarily translate into greater financial inclusion. To better harness these innovations, authorities—in cooperation with all relevant stake- technology and innovation holders, including the private sector and civil society—need to ensure Various United Nations entities contribute to ongoing efforts to enhance the provision of a broad range of enabling factors, including infrastructure, Member States’ capacity in STI to achieve the SDGs. This section discusses complementary technology, digital and financial education, as well as two key outcomes of the Addis Agenda: the United Nations Technol- an appropriate regulatory framework (see chapter II, and box III.G.2 on ogy Facilitation Mechanism (TFM), and the United Nations Technology enabling fintech for remittances). Bank for LDCs.

Box III.G.2 5.1 The Technology Facilitation Mechanism: an overview Enabling fintech for remittances in the Pacific small Despite limited resources, significant progress has been made towards island developing States a operationalization of the TFM. The Mechanism comprises four components: (i) the United Nations Interagency Task Team on Science, Technology and Remittance flows to small island developing States (SIDS) in the Innovation for the SDGs (IATT), which has 42 United Nations entities as Pacific amount to an average of 9.7 per cent of gross domestic members; (ii) the 10-Member Group of representatives from civil society, product (GDP) and are an important source of household income. Yet, the private sector and the scientific community, who work together with the cost of sending $200 of remittances to Pacific SIDS is among the the IATT to develop and operationalize TFM workstreams; (iii) the annual highest in the world, at an average of 11.6 per cent during 2011-2017. Multi-stakeholder Forum on Science, Technology and Innovation for These countries’ geographical constraints (isolation, remoteness and the SDGs (STI Forum); and (iv) the TFM online platform as a gateway for population dispersion) provoke severe infrastructure gaps that, in information on existing science, technology and innovation initiatives, and turn, contribute to the high operational costs of traditional financial as a platform for building partnerships and matchmaking.39 services, including remittances. In recent years, fintech services have entered the remittance markets Interim results of the start-up phase (2016-19): in most Pacific SIDS, offering competitive services at consistently lower prices. Nonetheless, the uptake of fintech services for remit- Key areas of work of the IATT include: tance transfers remains low in the region, with 72 per cent of Fijians, STI road maps and action plans to help realize the SDGs have been 92 per cent of Samoans and at least 83 per cent of Tongans who among the central topics addressed in the first four STI Forums. The receive money from abroad relying on traditional money transfer Group of Twenty (G20) outcome package (Osaka Leader’s Declaration, operators. This is likely due to a lack of necessary enabling factors: 2019) also contains guiding principles on STI for SDGs road maps. The in addition to the availability and accessibility of such services, there United Nations IATT subgroup for STI road maps has developed a joint is also a need for awareness on the side of consumers, as well as guidebook40 which is piloted in five countries: Ethiopia, Ghana, India, enhanced literacy and trust. Kenya and Serbia; As countries find themselves in different categories, policy recom- The new and emerging technologies subgroup has collected and mendations vary. Some countries like Kiribati, Marshall Islands, synthesized inputs—from both within the United Nations system and Micronesia (Federated States of), Nauru, Palau and Tuvalu could start external expert communities—on the impacts of rapid technol- by encouraging the availability of fintech services, while the more ogy change on the SDGs in the form of an informal document that pressing issue for countries like Papua New Guinea, Solomon Islands continues to grow,41 and has coordinated United Nations work on and Vanuatu is an increase in accessibility to such services, by improv- this topic;42 ing infrastructure coverage and quality. For countries that are more The subgroup on gender and STI has mapped relevant United Nations advanced in terms of fintech adoption, such as Samoa and Tonga, initiatives aimed at empowering women and girls in the field of STI policy emphasis should be geared towards awareness, financial through capacity-building, information sharing, policy setting and education and consumer confidence. Where fintech is already well awareness-raising (see also box III.G.5);

169 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

The IATT and the 10-Member Group has been working to operational- collaboration with the United Nations Conference on Trade and Develop- ize the online platform, 2030 Connect, which will provide access to a ment (UNCTAD) and the United Nations Educational, Scientific and Cultural wide range of resources, including publications, training opportunities, Organization (UNESCO). In 2020, an additional 10 countries will be added to and technology offers and requests; this assessment programme. The IATT also conducts joint training workshops (see boxes III.G.3 and Under the Digital Access to Research Programme, awareness-raising and III.G.4 for other examples of United Nations entities’ capacity-development workshops continued across 15 countries in 2019, capacity-building work).43 training over 1,000 researchers, academics and librarians from universities, research institutes, professional associations and government agencies. Box III.G.3 In 2020, the Technology Bank will partner with the Food and Agriculture Organization to deliver dedicated training to LDCs through an open Knowledge-sharing and capacity-building for online course. In 2019, the Technology Bank also initiated a programme technology development and innovation to strengthen existing national academies of science and to support the Through its global patent database, PATENTSCOPE, the World Intel- creation of academies withinin LDCs to improve scientific input to national lectual Property Organization (WIPO) provides access to international discourse and policymaking. Patent Cooperation Treaty applications as well as patent documents of participating national and regional patent offices. These contain key information for researchers to support technological develop- Box III.G.4 ment and innovation, and facilitate technology transfer. Other Development and transfer of the sterile insect services include a dedicated programme of work for least developed technique countries (LDCs) to support efforts in building or strengthening their Sterile insect technique (SIT) is an environmentally friendly insect innovation capacity. As part of this work programme, the Transfer pest-control method involving the mass rearing and sterilization of a of Appropriate Technology Program is designed to help beneficiary target pest, ultimately leading to a diminished wild population or to countries build an appropriate technology base in support of nation- its eradication without the use of chemical insecticidal. Over the past ally identified development needs. decades, the use of SIT has contributed to the cost-effectiveness of Access to Research for Development and Innovation (ARDI), a area-wide integrated pest management programmes. programme coordinated by WIPO together with its partners in the Following the significant progress made on the development of SIT publishing industry, aims to increase the availability of scientific and to control disease-transmitting mosquitoes—which are vectors technical information in developing countries and LDCs. Through the for dengue, chikungunya, Zika and yellow fever—the International Access to Specialized Patent Information, an initiative with leading Atomic Energy Agency (IAEA) has expanded the use of this technology patent information providers, eligible patent offices and academic to a variety of pests that have major economic impact. The transfer and research institutions in developing countries receive free or of the technology package to countries for field trials has allowed for low-cost access to sophisticated tools and services for retrieving and improved plant, animal and human health, cleaner environments, analysing patent data. increased crop and animal production, and accelerated economic Source: WIPO. development. Integrated with other control methods, SIT has been successful in controlling fruit flies, screwworms and moths. Pilot projects are being implemented to supress vector populations in STI Forum support and partnerships countries like Greece, Malaysia and Mexico. Launched in 2016, the annual STI Forum convenes participants from Source: IAEA. the public and private sectors, civil society and academia, to discuss STI solutions for achieving the SDGs. Forums have facilitated interaction, matchmaking and the establishment of networks between relevant stakeholders.44 The STI Forum also strengthens the science-policy interface by Box III.G.5 reporting to the High-level Political Forum on Sustainable Development The EQUALS Global Partnership for Gender Equality in in support of its review of SDG progress. The co-chairs of the STI Forum the Digital Age present outcomes to the Commission on Science and Technology for Development (CSTD), while the Chair of the CSTD presents its negotiated EQUALS is a multi-stakeholder partnership bringing together outcome to the STI Forum. international organizations, private sector companies, Governments, NGOs, regulatory agencies and academic institutions to bridge the gender digital divide. It aims to ensure that women and girls are 5.2 United Nations Technology Bank for Least Developed given access, equipped with skills, and supported in developing the Countries leadership potential to work and succeed in the information and The United Nations Technology Bank for Least Developed Countries was op- communications technology sector. Founded by GSMA, the Inter- erationalized in December 2018. In 2019, technology needs diagnostic work national Trade Commission, the International Telecommunications was initiated in Bhutan, the Gambia, Guinea, Timor-Leste and Uganda, in

170 SCIENCE, TECHNOLOGY, INNOVATION AND CAPACITY-BUILDING

Union, United Nations University, and UN-Women, the partnership courses on both hard tech skills and leadership skills. For example, counts on more than 90 partners to address the multiple facets of the the Business and Leadership for Women in the Technology Sector gender divide in technology across four areas (Access, Skills, Leader- course series focused on topics such as strategic management and ship and Research). how to digitalize your business. The Digital Skills Fund supports local Through its Leadership Coalition and Skills Coalition, partners work initiatives providing gender-sensitive skills training across countries together to identify and deliver tailored workshops and e-learning in the Global South. Other projects, such as the EQUALS Badges coordinated by EY, will help women develop future-focused skills.

Endnotes 1 ITU, Measuring digital development: Facts and figures 2019 (Geneva, ITU, 2019). Available at https://www.itu.int/en/ITU-D/Statistics/Pages/facts/default.aspx. 2 Ibid. 3 Addis Ababa Action Agenda of the Third International Conference on Financing for Development (Addis Ababa Action Agenda) (United Nations publication, Sales No. E.16.I.7), para. 119. 4 97 countries have data on STEM enrolment, but only 36 have sufficient data for a comparison with ten years ago. In 2018, about a quarter of tertiary education students were enrolled in STEM subjects, albeit with large variations by country, which are unrelated to levels of development. Shares were as low as 15 per cent of total students in Ghana or the Netherlands and as high as 40 per cent in Myanmar or Tunisia. 5 Only 84 countries report on this indicator. 6 OECD Statistics. Available at https://stats.oecd.org/ (accessed on 17 September 2019). 7 Addis Ababa Action Agenda, para. 117. 8 FDI Markets is a database that registers FDI announcements from companies and classifies them on several criteria, including the purpose of the investment. Available at https://www.fdimarkets.com/. 9 Including Hong Kong (SAR of China), Korea, Singapore and Taiwan (POC). 10 For a discussion of measurement challenges and a suggested methodology, see for example OECD, “Connecting ODA and STI for inclusive development: measurement challenges from a DAC perspective” (DCD/DAC(2019)38, 2 July 2019). Available at http://www.oecd.org/officialdocuments/publicdisplaydoc umentpdf/?cote=DCD/DAC(2019)38&docLanguage=En. 11 Financing for Sustainable Development Report 2019 (United Nations publication, Sales No. E.19.I.7), p. 160. 12 Ibid. 13 WIPO Patentscope database. Available at https://patentscope.wipo.int/search/en/search.jsf (accessed on 3 June 2019). 14 China particularly dominates the number of patents in big data, 3D printing and Internet of things (all of them over 50 per cent of the total), with a much lower presence in blockchain, gene editing or 5G. 15 KPMG, “Pulse of fintech H2 2019” (KPMG International, 2020), p. 9. Available at https://assets.kpmg/content/dam/kpmg/xx/pdf/2020/02/pulse-of- fintech-h2-2019.pdf. 16 KPMG, “The pulse of fintech 2018: biannual global analysis of investment in fintech” (KPMG International, 2019), p. 2. Available at https://assets.kpmg/ content/dam/kpmg/xx/pdf/2019/02/the-pulse-of-fintech-2018.pdf. 17 KPMG, “Pulse of fintech H2 2019”. 18 Bank for International Settlements, Annual Economic Report 2019 (Basel, Switzerland, Bank for International Settlements, 2019), pp. 61-62. Available at https://www.bis.org/publ/arpdf/ar2019e.pdf. 19 Ibid, p. 56. 20 Ibid, pp. 58-61. 21 GSMA, “2018 State of the Industry Report on Mobile Money” (London, GSMA, 2019), pp. 9-10. Available at https://www.gsma.com/ mobilefordevelopment/resources/2018-state-of-the-industry-report-on-mobile-money/. 22 An active consumer conducts at least one mobile money transaction during a 90-day period. 171 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

23 The Middle East and North Africa accounted for 6 per cent, while Latin America and the Caribbean and Europe and Central Asia accounted for 3 per cent and 1 per cent, respectively. 24 GSMA, “2018 State of the Industry Report on Mobile Money”, p. 19. 25 Ibid, p. 32. 26 Asli Demirgüç-Kunt and others, The Global Findex Database 2017: Measuring Financial Inclusion and the Fintech Revolution (Washington, D.C., World Bank, 2017), p.56. Available at https://globalfindex.worldbank.org/. 27 The Cambridge Centre for Alternative Finance defines alternative finance as “…technology-enabled online channels or models that act as intermediaries in the demand and supply of funding (e.g. capital formation and allocation activities) to individuals and businesses outside of the traditional banking system”. Coverage thus broadly corresponds to peer-to-peer lending and forms of online crowdfunding. Platforms that process payments, cross-border remittances and foreign exchange transactions are not included in the definition. See Tania Ziegler and others, 3rd Asia Pacific region alternative finance industry report (Cambridge, UK, Cambridge Centre for Alternative Finance, 2018), p. 30. Available at https://www.jbs.cam.ac.uk/faculty-research/ centres/alternative-finance/publications/3rd-asia-pacific-region-alternative-finance-industry-report/. 28 Tania Ziegler and others, Shifting paradigms: the 4th European alternative finance benchmarking report (Cambridge, UK, Cambridge Centre for Alternative Finance, 2019), p. 23. Available at https://www.jbs.cam.ac.uk/faculty-research/centres/alternative-finance/publications/shifting-paradigms/. 29 Tania Ziegler and others, The 2nd annual Middle East & Africa alternative finance industry report (Cambridge, UK, Cambridge Centre for Alternative Finance, 2018), p. 8. Available at https://www.jbs.cam.ac.uk/faculty-research/centres/alternative-finance/publications/middle-east-and-africa/. 30 Tania Ziegler and others, 3rd Asia Pacific Region Alternative Finance Industry Report; Tania Ziegler and others, Shifting Paradigms: The 4th European Alterna- tive Finance Benchmarking Report; Zhang and others, The 5th UK Alternative Finance Industry Report (Cambridge, UK, Cambridge Centre for Alternative Finance, 2018); and Tania Ziegler and others, Reaching New Heights: The 3rd Americas Alternative Finance Industry Report (Cambridge, UK, Cambridge Centre for Alternative Finance, 2018). 31 GSMA, “2018 State of the Industry Report on Mobile Money”, p. 33. 32 MicroSave Consulting, “Making Digital Credit Truly Responsible: Insights from Analysis of Digital Credit in Kenya” (MicroSave Consulting, 2019). Available at https://www.centerforfinancialinclusion.org/making-digital-credit-truly-responsible. 33 Chris Holmes, “The Rise and Fall of P2P Lending in China” (Finextra Research, 10 April 2019). Available at https://www.finextra.com/blogposting/17107/ the-rise-and-fall-of-p2p-lending-in-china. 34 GSMA, “Spotlight on Mobile-Enabled Microinsurance” (London, GSMA, 2018). Available at https://www.gsma.com/mobilefordevelopment/blog/ spotlight-on-mobile-enabled-microinsurance/. 35 UNSGSA FinTech Working Group, and Cambridge Centre for Alternative Finance, “Early Lessons on Regulatory Innovations to Enable Inclusive Fin- Tech: Innovation Offices, Regulatory Sandboxes, and RegTech” (New York, NY and Cambridge, UK, 2019). Available at https://doi.org/10.13140/ RG.2.2.28058.70088. 36 Since an online-survey methodology was used, only digitally active SMEs could be included. 37 EY,“Global FinTech Adoption Index 2019” (EY, 2019), pp. 22-23. Available at https://assets.ey.com/content/dam/ey-sites/ey-com/en_gl/topics/ financial-services/ey-global-fintech adoption-index-2019.pdf?download. 38 World Economic Forum, “Trade Tech – a New Age for Trade and Supply Chain Finance” (World Economic Forum, 2018). Available at https://www.weforum.org/whitepapers/trade-tech-a-new-age-for-trade-and-supply-chain-finance/; and Naoko Nemoto and Naoyuki Yoshino (eds.), Fintech for Asian SMEs (Tokyo, Japan, Asian Development Bank, 2019). Available at: https://www.adb.org/publications/fintech-for-smes. 39 For more details, see Multi-stakeholder Forum on Science, Technology and Innovation for the SDGs (STI Forum). Available at https://sustainabledevelopment.un.org/tfm#un. 40 For more details and latest version of the draft guidebook, see “Online information repository for the STI Roadmaps work.” Available at https://sustainabledevelopment.un.org/tfm#roadmaps. 41 For the latest presentation about the informal documentation at the 2019 STI Forum, see Alexander Trepelkov, “Update on the TFM findings on the impact of rapid technological change on the achievement of the SDGs” (New York, 14 May 2019). Available at https://sustainabledevelopment.un.org/ content/documents/28145AT_IATT_presentation_14_May_2019.pdf. 42 For the group’s work, see “Workstream 10: Analytical work on emerging technologies and the SDGs.” Available at https://sustainabledevelopment. un.org/index.php?page=view&type=12&nr=3335. 43 For details on training workshops, see “Multi-stakeholder Forum on Science, Technology and Innovation for the SDGs (STI Forum) EVENTS.” Available at https://sustainabledevelopment.un.org/tfm#events. 44 For all the STI Forum websites, see “Multi-stakeholder Forum on Science, Technology and Innovation for the SDGs (STI Forum).” Available at https://sustainabledevelopment.un.org/tfm#forum. 172

DATA, MONITORING AND FOLLOW-UP Chapter IV

Data, monitoring and follow-up 1. Key messages and recommendations

The rapid spread of digital technologies has caused a data Against the backdrop of these technological and institutional revolution that holds great opportunities, as well as challenges, transformations, the statistical community has continued to for sustainable development. Big data, together with machine work on strengthening methodologies for the provision of learning and artificial intelligence (AI), can help strengthen quality, timely and disaggregated data, as called for in the Addis official statistics for the implementation and monitoring of the Ababa Action Agenda. In addition to the global SDG indicators, Sustainable Development Goals (SDGs). Nonetheless, not all national and subnational indicators can support SDG monitor- countries have the capacity to harness these new data sources, ing and policymaking, and help identify financing gaps and questions remain around data security, access and privacy. and constraints as part of an integrated national financing framework. The SDG indicator framework underwent the 2020 Many countries still lack a minimum set of quality traditional comprehensive review, and countries, regions and cities have data, including basic census and civil registration data. At started to design their own place-specific indicator sets. Despite the same time, the emergence of a new and evolving data progress, there is also still a need to further develop and estab- ecosystem around new technologies, data sources and actors lish concepts, definitions and methods for gender statistics. is challenging the traditional role of official statistical systems as the predominant producers of statistics and providers of In view of the limitations of gross domestic product (GDP) and information for policymaking. GDP per capita for measuring sustainable development, efforts are ongoing to provide statistical guidance on the measure- National statistical systems need to modernize and the ment of well-being that incorporates the impact on the capacities of their member entities need to be strengthened, environment and on progress in education, health and gender to enable them to fill development data gaps and establish equality, among others, as called for in the Addis Agenda. their new role in a changing data ecosystem. This requires Based on this guidance, national accounting frameworks will a step-change in resource mobilization for statistics. New need to be integrated with different measures of well-being financing mechanisms can help pool external funding from to better reflect all three dimensions of development—eco- different sources, mobilize additional funding and increase nomic, social and environmental. sector coordination. They should support strengthening and modernization of national statistical systems and align with This chapter discusses initiatives and mechanisms to address countries’ national statistical plans. funding needs for statistics. It then considers options to reposition official statistics in the context of an evolving data ecosystem. As national Governments reconsider the role of data manage- It reviews progress on data frameworks, measurements and data ment in information and technology-based societies, many are collection, and gives an update on monitoring the financial sector. looking beyond legal frameworks for data security and privacy. They are beginning to review national data strategies and new institutional set-ups, including a potential role for national statistical offices as data stewards. For these efforts to succeed, 2. Funding for data for national Governments should view data as a strategic asset for development, and task and capacitate their national sustainable development statistical systems—in collaboration with other government To meet the data requirements of the 2030 Agenda for Sustain- entities—to actively use and develop this asset. able Development, national statistical systems (NSSs)—the 175 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

ensemble of statistical organizations and units within a country that Global Civil Registration and Vital Statistics Scaling Up Investment Plan that develop, produce and disseminate official statistics on behalf of the Gov- covers activities in 73 countries over a 10-year period. Its projected total cost ernment—need to be strengthened and modernized, and the capacities is $3.82 billion (excluding China and India), with an estimated funding gap of their member entities increased. The Cape Town Global Action Plan for of $1.99 billion, to be closed by a combination of additional domestic and Sustainable Development Data lays out how this can be achieved, including international resources.5 Further commitments for sectoral data funding both by strengthening traditional and embracing new sources of data. It are currently materializing under the nineteenth replenishment of the also provides a basis for estimating additional funding requirements. In International Development Association (IDA19).6 addition to increased domestic funding, joint international efforts will While these initiatives mobilize sizable international and domestic invest- need to be stepped up to support developing countries, particularly least ments, large financing gaps remain. In addition, many initiatives focus developed countries (LDCs). primarily on data funding for specific sectors. Funding mechanisms with a specific sectoral focus can have the advantage of galvanizing donors and 2.1 The Cape Town Global Action Plan for Sustainable philanthropies around shared priorities, leveraging sectoral expertise and Development Data: priorities and funding needs becoming hubs for knowledge-sharing. There is a risk, however, of advancing The Cape Town Global Action Plan for Sustainable Development Data selected areas in line with donor priorities, without strengthening countries’ (CTGAP), adopted by the United Nations Statistical Commission in March 2017, NSSs as a whole. A lack of alignment with country systems and priorities could 7 lays out a set of actions for transforming national statistical systems to ad- also lead to reduced country ownership and development effectiveness. dress and meet the data needs of the 2030 Agenda. It identifies six strategic Renewed efforts to increase and harmonize funding are currently areas: (i) strengthening national statistical systems and improving coordina- underway, including reforms to donor financing mechanisms/trust tion; (ii) modernizing statistical systems and embracing new technologies funds, strengthened global partnerships and targeted multi-stakeholder and data sources; (iii) strengthening basic statistical activities covering cooperation. The United Nations-World Bank Group Strategic Partner- statistical, administrative and other data sources; (iv) improving dissemina- ship Framework for the 2030 Agenda, launched in 2018, includes a focus tion and use of data; (v) developing and strengthening multi-stakeholder on realizing the data revolution through more concerted efforts to fill partnerships for sustainable development data; and (vi) mobilizing resources data gaps.8 Also in 2018, the Second United Nations World Data Forum and coordinating efforts for statistical capacity-building. adopted the Dubai Declaration, calling for the establishment of an innova- According to recent estimates, the cost for support for data and statistical tive funding mechanism to support the implementation of CTGAP. The systems for the full implementation of CTGAP through 2030 is approxi- High-level Group on Partnership, Coordination and Capacity-Building has mately $5.6 billion per year for 75 low- and lower-middle-income countries worked to define guiding principles and modalities for the establishment and 69 upper-middle-income countries. An estimated $4.3 billion (77 of this mechanism.9 The Bern Network on Financing Data for Develop- per cent) of the total could be covered by domestic resources, leaving a ment, a multi-stakeholder community of data and statistics-focused financing gap of $1.3 billion (23 per cent) per year to be filled from external development practitioners, donors, and advocates, is working towards the sources.1 As of 2017, total official development assistance for data and launch of commitments at the Third United Nations World Data Forum in statistics was $689 million, approximately half of the amount needed.2 October 2020.10

2.2 Initiatives and funding mechanisms for the data needs Lessons learned from other global funds: success factors of the 2030 Agenda for Sustainable Development Several global funds have been established to address challenges in specific Chronic under-investment in many statistical systems, particularly in sectors, such as the Global Fund to fight AIDS, Tuberculosis and Malaria (or developing and least developed countries, has caused significant gaps in Global Fund, see also chapter III.C); the Global Partnership for Education; development data. In the past, external support for development data and, most recently, the 50x2030 Initiative for Data to End Hunger. While funding has often been tied to the monitoring of specific donor-supported targeting different sectors, these funds share several common elements investments in other thematic areas, such as health. Funding volumes that may have contributed to their success: (i) pooling of funds and have been small and often directed towards one-off instruments, with coordination of resource allocation within the sector; (ii) placing target little harmonization among different donors and limited streamlining with countries in the lead of in-country efforts; and (iii) coordination through a national statistical plans.3 Board that includes target countries. Another key lesson from the Global Since 2015, multilateral and bilateral development partners and philan- Fund is the importance of going beyond financing and becoming a hub for thropies have made new global commitments for data and statistics. For knowledge-sharing on the implementation of national policies. example, in 2015, the World Bank, working with a range of developing coun- The pooling of donor funds may also help leverage additional concessional tries and several international partners, committed to conducting triennial and non-concessional resources (e.g., World Bank International Develop- household-level surveys in the 78 poorest nations, with the first round to be ment Association or International Bank for Reconstruction and completed by 2020. The estimated cost of the initiative—$300 million every Development resources), which can be complemented by increased three years during the period 2015-2030—is expected to be borne by a mix- domestic financing. Such a three-pronged approach—pooling donor ture of countries’ own resources, donor funding and World Bank financing.4 resources, leveraging additional resources and increasing domestic Also in 2015, several developing countries and development organizations, financing —could contribute to a step change in more sustainable including the World Bank and the World Health Organization, launched the financing for data and statistics. It was successfully applied in the 50x2030 176 DATA, MONITORING AND FOLLOW-UP

Initiative for Data to End Hunger, launched in 2019 (see box IV.1). The World modernization process, including by standardizing statistical production Bank and several key partners have also spearheaded the launch of an processes and implementing new initiatives and partnerships. They are Umbrella Trust Fund for Data to scale up this approach across key sectors increasingly using new big data sources and integrating geospatial and and a range of low-income and middle-income countries, while ensuring a statistical data, which can strengthen monitoring of SDG implementation country-led, flexible, and adaptive approach to strengthen the capacity of and provide the necessary data and analysis for evidence-based policy- national data and statistical systems.11 making. At the international level, this work is supported by the High-level Group for the Modernisation of Official Statistics, the Global Working Group Box IV.1 on Big Data for Official Statistics and the United Nations Committee of Data to End Hunger: the 50x2030 initiative Experts on Global Geospatial Information Management, among others.13 In 2019, a coalition of low-income countries, bilateral donors, These efforts by national statistical offices (NSOs) and the larger national multilateral organizations and philanthropies committed significant statistical systems are part of a broader shift, as many national Govern- funding in a single multi-donor trust fund mechanism to support ments are reconsidering the role of data management in an information agriculture statistics across 50 low- and lower-middle-income coun- and technology-based economy and society. This shift is most noticeable tries in Africa, Asia and Latin America by 2030. The goal is to support in legal efforts to protect the use and privacy of individual data, but also in key agriculture statistics for targeted food production solutions, new attempts to better utilize government and private data for policymak- including increasing sustainable production by smallholder farmers ing and the delivery of government services. In this context, some in these countries by the 2030 impact deadline. To enable this, Governments are developing data and e-government strategies and are several donors collaboratively committed an estimated $200 million otherwise rethinking their institutional set-up. Some have also been or are in a World Bank Trust Fund, which has so far leveraged $300 million considering creating new government positions such as chief data officer, of World Bank Regional International Development Association for chief data scientist or chief data steward. Other countries are assigning the investments in the African region and mobilized further domestic responsibilities associated with these positions to existing government resources in individual countries. structures (see box IV.2 on the possible roles of NSOs as data stewards). Source: World Bank. Box IV.2 Possible roles of a government data stewarda As part of efforts to reposition official statistics, National Statisti- 3. New sources of data and evolving cal Offices (NSOs) may take on the new role of government data stewards. In this role, NSOs could set standards and guidelines for the national statistical systems collection, management and use of government data by government agencies, and direct them in the adoption of common capabilities 3.1 Opportunities and challenges around new sources of such as data tools or linking data infrastructure. This would foster data the development of a comprehensive and integrated data system The increased use of digital technology over the past two decades has that would aim to facilitate the use of government data for public driven a ‘data revolution’. Big data, in combination with processing tech- and private purposes while safeguarding confidentiality and data nologies such as machine learning and AI, has become a powerful tool that security. NSOs may also become custodians and repositories of all can support evidence-based policymaking and strengthen the monitoring government data. of SDG implementation. If managed effectively, big data from a variety a Based on United Nations Economic and Social Commission for Europe, of sources can contribute to the production of integrated and highly “Broadening our role as a national statistical office – New Zealand’s journey disaggregated statistics across the economic, social and environmental so far”, Note by Statistics New Zealand (ECE/CES/2019/28). development pillars.12 The growing role of new technologies, data sources and actors has driven Where sufficient capacity, supporting infrastructure and regulation exist, the establishment and rapid growth of a vast marketplace for individual NSOs and NSSs can take on additional roles and responsibilities, from data, where data demands have dramatically increased. At the same time, broadening data collection approaches to becoming “infomediaries” by there are rising concerns about the use and access to such data, as well assuming a stronger coordination and dissemination role across an 14 as data privacy and security. This new and evolving data ecosystem chal- expanding constellation of data producers. Innovative NSO models and lenges the role of official statistical systems as the predominant producers functions (e.g., in New Zealand and Mexico) may serve as a blueprint for of statistics and providers of information for policymaking, and forces this evolution. Support from NSO peers and development organizations, them to update their vision, strategy and role. together with new modes of collaboration and partnership mechanisms, could help systematize such transformations in developing countries. 3.2 The changing role of national statistical systems as part As countries are rethinking the role of data management, they may also need to review, adjust and modernize the National Strategies for the of Governments’ evolving digital strategies Development of Statistics (NSDS) for their national statistical systems.15 Many official statistical systems around the world have responded For these efforts to succeed, Governments need to view data as a strategic to changes in the data ecosystem by embarking on an ambitious asset for development, and task and capacitate NSSs—in collaboration 177 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

with other government entities and stakeholders from the broader data In September 2019, the United Nations Deputy-Secretary General launched community—to actively use and develop this asset. a new initiative, Data For Now (Data4Now),17 which aims to improve the timeliness, coverage, and quality of SDG data. The initiative involves work- 3.3 Developments across regions ing closely with NSOs and all relevant government agencies in selected pilot countries, to develop their capacity to mainstream new data sources In Europe, official statistics has focused on the modernization of statistical and solutions to fill data gaps. Additional work aims at identifying solu- offices and production processes and the gradual integration of new data tions that can be scaled up and applied to a larger number of countries. sources, while policy efforts have emphasized the protection of individual Capacity development is also needed to improve coordination within data, leading to the adoption of the European Union (EU) General Data statistical systems and to increase the statistical capabilities of all NSS Protection Regulation in 2018 (see chapter II). The impact of the latter is member entities. Ongoing initiatives in this area include PARIS21 support felt beyond the borders of the EU, and it has become the de facto regula- for National Strategies for the Development of Statistics and endeavours to tion in many countries. build and strengthen national reporting and dissemination platforms. In regions with less developed NSSs, efforts are directed at the use of new data sources. However, the capacity to use new sources is often lag- ging, and access to new data is limited, causing many projects to remain 4. Progress in strengthening data isolated and focused on specific purposes. Additional capacity-building and funding will be needed to scale up successful projects and fulfil the frameworks, measurements and data expectations for the data revolution in these countries. For example, the Asia-Pacific statistical community is exploring a range collection of frontier technologies in NSSs. The Governments of the Philippines and Efforts are ongoing at the international, national and regional levels to Thailand are piloting the use of geospatial data, integrated with official improve the availability and use of high-quality, timely, reliable and statistics, in support of the SDGs and the Sendai Framework for Disaster disaggregated data in support of the SDGs. This includes progress on the Risk Reduction. Indonesia, Georgia and Thailand are working on using SDG indicator framework, as well as the development and use of additional mobile phone data to improve human mobility and tourism statistics. In national and subnational indicators. Significant progress has been made in addition, new partnership models with the private sector are emerging. advancing gender data, but more work is needed for a regular production Some countries have also established data hubs by linking and integrating of all gender-specific SDG indicators. In recognition of the limitations of per individual data from different data sources and making them available capita income, new national accounting guidelines are being developed to for data analysis and decision-making. The United Nations Economic and improve the measurement of well-being and sustainable development. Social Commission for Asia and the Pacific is supporting peer learning, including by convening groups of experts and partner countries to discuss 4.1 Progress on the SDG indicator framework and share experiences in the use of big data and emerging techniques for During 2019, the Inter-agency Expert Group on SDG Indicators (IAEG-SDGs) statistical production. undertook a comprehensive review of the global indicator framework and proposed 36 major changes for review by the United Nations Statisti- 3.4 Capacity-building to make national statistical systems cal Commission in March 2020 (table IV.1 summarizes the proposed fit for purpose major changes for SDG 17). The proposed changes aim to (i) enhance the target-indicator mapping; (ii) ensure that all critical aspects of a target or Many NSSs, particularly in developing countries, lack the necessary capaci- goal are covered by an indicator; and (iii) ensure that all indicators have an ties and resources to embrace the opportunities and meet the challenges established methodology.18 of the data revolution, and require support to realize their new role in a changing data ecosystem. The IAEG-SDGs and its working groups continue to work on the implementation of the indicator framework, including data disaggregation and The United Nations Statistical Commission and its High-level Group for reporting on vulnerable groups, statistical data and metadata exchange, Partnership, Coordination and Capacity-Building for Statistics for the geospatial information, and interlinkages. The IAEG-SDGs also proposed to 2030 Agenda for Sustainable Development are at the centre of efforts to further address the development of a new measurement of development strengthen NSSs by establishing a global partnership for sustainable devel- support (see chapter III.C).19 opment data. One example for strengthening the core capacities of NSSs is the joint project of the Statistics Division of the United Nations Department Countries have been mainstreaming the SDGs into their national develop- of Economic and Social Affairs (UNSD) and the Department for Interna- ment plans and establishing indicator frameworks and monitoring systems, tional Development of the United Kingdom of Great Britain and Northern but limited data availability and a lack of disaggregation remain a chal- Ireland, which aims to make SDG indicators available to a broad audience lenge in both developed and developing countries. Many countries have and to strengthen countries’ capacity in their compilation and use in also been developing national indicators which, along with the global SDG 20 countries in Africa and Asia. Similarly, UNSD and the United Nations indicators, demonstrate the progress that can be achieved in those areas Regional Commissions and Specialized Agencies, Funds and Programmes where data is available. run a joint $10 million programme to strengthen NSSs for the follow-up As cities and regions around the world are increasingly using the SDGs to and review of the SDGs, including by addressing specific data gaps.16 shape their local development strategies and plans, many have started to 178 DATA, MONITORING AND FOLLOW-UP design and implement their own, place-specific indicators. Building on National Strategies for the Development of Statistics.22 Since 2018, the these efforts, several international groups and initiatives, including the International Monetary Fund (IMF) has made gender data an integral Organization for Economic Cooperation and Development (OECD), have part of the Financial Access Survey (FAS).23 In 2019, the number of coun- been developing localized indicator frameworks.20 Additional work will tries providing this data increased to 49, up from 35 in 2018. Close to half be required to turn such frameworks into useful policy tools, especially of the gender data reporters in the FAS are LDCs and other lower-middle- in the case of developing countries where data at the subnational level is income countries, suggesting the growing availability of this data to particularly scarce. inform policymaking. Improving data availability at both the national and subnational levels can Efforts to improve gender statistics are underpinned by work to establish also help identify financing gaps and constraints, which are key elements concepts, definitions and methods for gender statistics and the provision of integrated national financing frameworks. of practical guidelines, such as the development of a Minimum Set of Gender Indicators.24 Table IV.1 Proposed changes of indicators for SDG 17: Strengthen the means of implementation and revitalize the global partnership for sustainable development 4.3 Measurements of sustainable development beyond GDP Existing indicators Proposed changes The main measures of a country’s economic performance are GDP and GDP Target 17.3, Indicator 17.3.1 Replace with: Foreign direct investment, per capita. However, these measures are only focused on economic activity Foreign direct investment (FDI), official official development assistance and South- and are thus insufficient for measuring progress in sustainable develop- development assistance and South-South South cooperation as a proportion of gross ment. In the Addis Agenda, Member States called on the United Nations cooperation as a proportion of total national income domestic budget system to develop transparent measurements of progress on sustainable development that go beyond GDP per capita, and that account for the Target 17.5, Indicator 17.5.1 Revise to: Number of countries that adopt Number of countries that adopt and imple- and implement investment promotion social, economic and environmental dimensions of development.25 In its ment investment promotion regimes for regimes for developing countries, including 2009 report, the Commission on the Measurement of Economic Perfor- least developed countries the least developed countries mance and Social Progress (Stiglitz-Sen-Fitoussi Commission) concluded Target 17.6, Indicator 17.6.1 Delete that GDP was not a measure of well-being and called for more attention to Number of science and/or technology cooperation agreements and programmes the indicators of income, consumption and wealth that are also included between countries, by type of cooperation in the System of National Accounts. It further called for the development Target 17.17, Indicator 17.17.1 Replace with: Amount of United States of new statistics to close the gap between aggregate production data and Amount of United States dollars committed dollars committed to public-private partner- citizen’s well-being.26 to (a) public-private partnerships and (b) ships for infrastructure civil society partnerships The measurement of environmental sustainability has been advanced Target 17.18, Indicator 17.18.1 Replace with: Statistical capacity through the System of Environmental Economic Accounts (SEEA), which Proportion of sustainable development indi- indicator for Sustainable Development Goal includes monitoring of negative externalities such as emission of pollutants, cators produced at the national level with monitoring and the measurement of natural resources (and of their depletion), among full disaggregation when relevant to the 27 target, in accordance with the Fundamental others. Increasing efforts have also been made over the past decade Principles of Official Statistics to emphasize indicators of economic welfare both within the national Source: Statistical Commission, “Report of the Inter-Agency and Expert Group accounts framework as well as beyond it, to better measure people’s living on Sustainable Development Goal Indicators” (E/CN.3/2020/2). conditions. These include the IMF Sixth Statistical Forum on Measuring Economic Welfare in the Digital Age: What and How?;28 the OECD dashboard on households’ economic well-being;29 the World Bank’s wealth 4.2 Gender statistics accounting initiative;30 and the Eurostat-OECD data on more granular An increasing share of projects on statistical capacity development distributional information on income, consumption, saving and wealth of contain components that target gender statistics. Between 2015 and 2017, households.31 Compilation guidance has also been developed for measur- approximately 11 per cent of commitments to statistics from bilateral ing unpaid household activities,32 education,33 health34 and gender donors targeted gender data, up from three per cent between 2010 and equality.35 Moving beyond economic welfare requires the incorporation 2012 (figure IV.1). However, despite this positive trend, additional efforts of additional quality-of-life elements, as highlighted in the OECD Better are needed, as many of the 54 gender-specific SDG indicators are not Life Initiative.36 New and emerging areas for measurement and analysis currently produced with sufficient regularity to meet the SDG monitoring of well-being, including inequalities, sustainability, vulnerability and resil- requirements.21 ience, were published in the final 2019 reports of the OECD High-level Group 37 The UN-Women flagship programme “Making Every Woman and Girl on the Measurement of Economic Performance and Social Progress. Count”—a $61 million programme currently funded at about 66 per Moving the statistical measurement framework beyond GDP requires addi- cent ($40.5 million)—aims at creating an enabling environment by tional work on integrating the central framework of the System of National increasing the production, access and use of gender statistics in line Accounts and the accounting framework of the SEEA with the different with national priorities and the 2030 Agenda. For instance, in coopera- measurements of well-being. This would facilitate the monitoring and tion with PARIS21, it supports developing countries in integrating analysis of the interrelationships between the traditional set of measures sex-disaggregation and gender-specific data collections into their of economic activity and the broader measures of various aspects of 179 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

Figure IV.1 Share of commitments to gender statistics in bilateral donors’ overall commitment to statistics, 2010–2017 (Percentage)

7 6.9 6.4 6

4.1 4 3.6 3.1 3 2.6 1.8 2 1.8 1.2

1 0.6 0.4 0.5

0 2010–2012 2011–2013 2012–2014 2013–2015 2014–2016 2015–2017

Statistical activities of which gender statistics is the primary component Statistical activities of which gender statistics is a non-primary component

Source: PARIS21, “Partner report on support to statistics” (Paris, 2019).

well-being and sustainability, and could provide a better understanding international banking statistics, and government finance statistics.40 of potential synergies and trade-offs between the economic, social and Remaining challenges for the timely achievement of all DGI-2 recommenda- environmental dimensions. tions include the full implementation of international banking statistics; In 2018, the Intersecretariat Working Group on National Accounts, under improved periodicity and timeliness of financial stability indicators; and the the auspices of the United Nations Statistical Commission, initiated a work complete reporting of quarterly general government debt and operations. programme to produce guidance on integrated measures of economic While progress has been made in data sharing, further efforts are needed to activity, well-being and sustainability.38 Work is also ongoing on aspects improve it within and across countries. High-level political support will be related to informality in the economy; education and human capital; essential to overcome these challenges, as well as the continuing work from health and social conditions; distribution of household income, expendi- the IMF, the secretariat of the Financial Stability Board and the Inter-Agency ture and wealth; and unpaid household work. Draft guidance notes on the Group on Economic and Financial Statistics, including through technical integrated measurement of these issues are expected during 2020. assistance, thematic workshops and the annual DGI Global Conference.41 Continuing efforts are also being made to improve international debt statistics, in order to enhance the transparency of both external and 5. Monitoring the financial sector domestic debt and reduce public debt vulnerabilities (see chapter III.E). The World Bank Group has been strengthening its Debtor Reporting System The Group of Twenty (G20) Data Gaps Initiative (DGI) aims to address (DRS)—which captures World Bank borrowers’ external public sector debt important data gaps in the financial sector that were revealed by the 2008 and private sector debt with a public-sector guarantee, as well as other world financial and economic crisis. The second phase of the Initiative non-guaranteed external private sector debt—through higher frequency (DGI-2) commenced in 2015 and is focused on (i) monitoring risk in the reporting; better monitoring of data quality and follow-through on report- financial sector; (ii) vulnerabilities, interconnections and spillovers; and (iii) ing obligations; outreach to official creditors that lend without guarantee; data sharing and communication of official statistics.39 and enhanced use of data on national websites and from market sources.42 As DGI-2 is approaching its completion date in 2021, countries have advanced Collaborative efforts across countries and institutions are also underway, in closing data gaps and moved closer to the goal of implementing regular on a pilot basis, to strengthen domestic debt data reporting capacity and collection and dissemination of reliable and timely statistics for policy use. improve the quality of domestic debt recording and classification. The Joint During 2019, important progress was made on: the work on financial sound- External Debt Hub (JEDH) is another central repository for external debt ness indicators (FSIs); derivatives data, with ongoing work on governance data and selected foreign assets of developed, developing and transition arrangements for Unique Product Identifiers (UPI); actions to reduce barriers countries and territories, managed jointly by the Wold Bank Group, IMF, to over-the-counter derivatives trade data reporting; and on reporting on OECD and the Bank for International Settlements.43 In November 2019, sectoral accounts, international investment position, securities statistics, the United Nations Conference on Trade and Development (UNCTAD),

180 DATA, MONITORING AND FOLLOW-UP together with the Commonwealth secretariat, launched a Debt Data Qual- Approach for Addressing Emerging Debt Vulnerabilities, the joint Debt ity Assessment framework to review the quality of the data recorded in Management Facility entered its third phase in April 2019, with an countries’ debt databases. enhanced focus on debt transparency and fiscal risks, and increased The IMF is continuing to assist countries in graduating to the Special Data support for the implementation of the Medium-Term Debt Management 44 Dissemination Standard (SDDS) and SDDS Plus, supported by its Data for Strategy. Decisions Fund. In addition, as part of the IMF-World Bank Multi-Pronged

Endnotes 1 PARIS21, “Financing challenges for developing statistical systems: A review of financing options”, PARIS21 Discussion paper No. 14 (Paris, 2019). 2 PARIS21, “Partner report on support to statistics: PRESS 2019” (Paris, 2019). Available at https://paris21.org/sites/default/files/inline-files/PARIS21_ Press%202019_WEB.pdf. 3 The Bern Network, “Financing more and better data to achieve the SDGs”, pp. 16-17. Available at https://paris21.org/sites/default/files/2019-07/Bern- DraftReport_SoftCopy_FINAL.pdf. 4 World Bank, “World Bank’s new end-poverty tool: Surveys in poorest countries.” Available at https://www.worldbank.org/en/news/ press-release/2015/10/15/world-bank-new-end-poverty-tool-surveys-in-poorest-countries. 5 World Bank and WHO, “Global civil registration and vital statistics scaling up investment plan 2015-2024” (Washington, D.C., World Bank, May 2014). Available at https://www.worldbank.org/en/topic/health/publication/global-civil-registration-vital-statistics-scaling-up-investment. 6 World Bank, “IDA19 Replenishment.” Available at http://ida.worldbank.org/replenishments/ida19-replenishment. 7 See, for example, The Bern Network, “Financing more and better data to achieve the SDGs”. 8 World Bank, “UN-WBG Strategic Partnership Framework.” Available at https://www.worldbank.org/en/programs/sdgs-2030-agenda/brief/ strategic-partnership-framework-for-the-2030-agenda. 9 See United Nations, document E/CN.3/2020/4; and Statistical Commission, “Financing for data and statistics: enriched national statistical systems to support the 2030 agenda for sustainable development” (background document). Both available at https://unstats.un.org/unsd/statcom/51st-session/ documents/. 10 The Bern Network, “More and better development data for a decade of action.” Available at https://paris21.org/sites/default/files/inline-files/Bern%20 Network%20Paper%20-%20short%20version%20%282020.01.06%29%20%28web-ready%29.pdf. 11 See, for example, World Bank, “An Umbrella Approach to IBRD/IDA Trust Funds.” Available at http://siteresources.worldbank.org/EXTCFPDONFOR/ Resources/1168942-1332859111462/UF_Brief.pdf; World Bank, “2018-2019 Trust Fund Annual Report.” Available at https://www.worldbank.org/en/publication/trust-fund-annual-report-2019/tf-fif-reforms/trust-fund-reform; and Penny Goldberg, “Toward more and better financing for data and statistics: Country-led priorities, new commitments, and enhanced international coordination” in International Newsletter from the Swiss Federal Statistical Office (Swiss Confederation, Federal Statistics Office, December 2019), pp. 3-5. Available at https://www.bfs.admin.ch/bfsstatic/dam/assets/11407347/master. 12 See also Financing for Sustainable Development Report 2019 (United Nations publication, Sales No. E.19.I.7), pp. 171-172. 13 Ibid, pp. 172-174. 14 Shaida Badiee and others, “The role of national statistical systems in the data revolution”, in Development Co-operation Report 2017: Data for Development (Paris, OECD, 2017). Available at https://www.oecd-ilibrary.org/docserver/dcr-2017-8-en.pdf?expires=1575591751&id=id&accname=guest&checksum= 26FB3A653271AE017B3727B1CDBA3294. 15 To ensure alignment with national priorities, National Strategies for the Development of Statistics should be closely linked to national sustainable development strategies and incorporated into integrated financing frameworks. See Financing for Sustainable Development Report 2019 (United Nations publication, Sales No. E.19.I.7), p. 171. 16 UN DESA Statistics Division, “UNSD-DFID Project on SDG Monitoring.” Available at https://unstats.un.org/capacity-building/unsd-dfid/. 17 UN DESA Statistics Division, “Data4 Now Initiative.” Available at https://unstats.un.org/home/# and https://www.un.org/sg/en/content/dsg/ statement/2019-09-25/deputy-secretary-generals-remarks-data-for-now-event-%E2%80%98better-decisions-better-lives-accelerating-sdg- progress-through-timely-data%E2%80%99-prepared-for-delivery. 18 United Nations, document E/CN.3/2020/2. Available at https://unstats.un.org/unsd/statcom/51st-session/documents/2020-2-SDG-IAEG-E.pdf. 19 Ibid, pp. 7-8. 181 2020 FINANCING FOR SUSTAINABLE DEVELOPMENT REPORT

20 A Territorial Approach to the Sustainable Development Goals: Synthesis report (Paris, OECD, 2020). Available at http://www.oecd.org/cfe/ territorial-approach-sdgs.htm. 21 PARIS21, “Partner report on support to statistics: PRESS 2019”, p. 21. 22 UN Women, “Making Every Woman and Girl Count. 2018 Annual Report: Implementation Phase.” (New York: UN Women, 2019), pp. 18-19. Available at https://data.unwomen.org/publications/making-every-woman-and-girl-count-2018-annual-report-implementation-phase. 23 IMF Data, “Financial Access Survey (FAS).” Available at https://data.imf.org/?sk=E5DCAB7E-A5CA-4892-A6EA-598B5463A34C. 24 UN DESA Statistics Division, “Minimum set of gender indicators.” Available at https://genderstats.un.org/#/home. 25 Addis Ababa Action Agenda of the Third International Conference on Financing for Development (Addis Ababa Action Agenda) (United Nations publication, Sales No. E.16.I.7), para. 129. 26 Joseph E. Stiglitz, Amartya Sen and Jean-Paul Fitoussi, “Report by the Commission on the Measurement of Economic Performance and Social Progress” (2009). Available at https://ec.europa.eu/eurostat/documents/118025/118123/Fitoussi+Commission+report. 27 United Nations, “System of Environmental Economic Accounting.” Available at https://seea.un.org/. 28 IMF, The Sixth IMF Statistical Forum: Measuring Economic Welfare in the Digital Age: What and How. Available at https://www.imf.org/en/News/ Seminars/Conferences/2018/04/06/6th-statistics-forum. 29 OECD, “Households’ economic well-being: the OECD dashboard.” Available at http://www.oecd.org/sdd/na/household-dashboard.htm. 30 World Bank, “Wealth Accounting.” Available at https://datacatalog.worldbank.org/dataset/wealth-accounting. 31 OECD, “Income distribution database.” Available at https://stats.oecd.org/Index.aspx?DataSetCode=IDD. 32 UN-ECE, “Guide on valuing unpaid household service work” (ECE/CES/STAT/2017/3). Available at https://www.unece.org/fileadmin/DAM/stats/publications/2018/ECECESSTAT20173.pdf. 33 UN-ECE, “Satellite account for education and training: compilation guide” (ECE/CES/STAT/2020/1). Available at https://www.unece.org/fileadmin/DAM/ stats/documents/ece/ces/ge.20/2019/GuideSAET__Draft__Nov_2019_.pdf. 34 WHO, “Health Accounts.” Available at https://www.who.int/health-accounts/en/. 35 UN DESA Statistics Division, “Evidence and data for gender equality.” Available at https://unstats.un.org/edge. 36 OECD, “Better Live Initiative: measuring well-being and progress.” Available at www.oecd.org/statistics/better-life-initiative.htm. 37 Beyond GDP: Measuring what counts for economic and social performance (Paris, OECD Publishing, 2019) and For Good Measure: Advancing Research on Well-Being Metrics Beyond GDP (Paris, OECD Publishing, 2019). 38 System of National Accounts, “Presentation on the objectives and progress of the sub-group on well-being and sustainability” (SNA/M1.19/2.4.1, October 2019). Available at https://unstats.un.org/unsd/nationalaccount/aeg/2019/M13_2_4_1_Wellbeing_Sustainability_Subgroup.pdf. 39 Economies participating in the second phase of the Data Gaps Initiative (DGI) are the G20 economies and five non-G20 FSB member economies (Hong Kong, the Netherlands, Singapore, Spain and Switzerland). Member agencies of the Inter-Agency Group (IAG) on Economic and Financial Statistics are the Bank for International Settlements, European Central Bank, Eurostat, International Monetary Fund (Chair), Organization for Economic Co-operation and Development, United Nations and the World Bank. The Financial Stability Board (FSB) participates in the IAG meetings. 40 See International Monetary Fund and Financial Stability Board, Second Phase of the G20 Data Gaps Initiative (DGI-2): Fourth Progress Report – Countdown to 2021 (2019). 41 Ibid. 42 Mark Flanagan, “Debt transparency to the rescue? Possibilities and Limitations.” Available at https://unctad.org/meetings/en/Presentation/2019_ panel2_flanagan.pdf. 43 See the website of the Joint External Debt Hub. Available at http://www.jedh.org/index.html. 44 Mark Flanagan, “Debt transparency to the rescue? Possibilities and Limitations”.

182

CMY CY MY CM K Y M C

19-0108420-02510 Cover_Final-2b-11x17-2020.pdf 13/31/201:29PM

f inancing F e D ustainable S or n elopme v r Repo t t t 2020 Financing forSustainableDevelopmentReport2020 Inter -agency T D D omestic P omestic P Resour Resour ask For D D ebt ebt c c es es ublic ublic ce onFinancingforDevelopment P P riv riv and F and F a a S S t t yst yst Issues Issues e B e B inanc inanc emic emic usiness usiness e e D D and C and C C C T T ev ev ooper ooper echnology echnology elopmen elopmen apacit apacit a a tion tion y y t t MORE READ T T r r ade ade